Variable Rate or Fixed Rate Home Loans? -Part 2

by Adam on July 28, 2010

Buying a house is something I think many people rush into without realising the implications of making what likely is the most expensive thing you’ll ever buy.

It’s a more advanced financial topic that Magical Penny will be exploring in the coming months. However for those of you who are about to buy a house or are considering refinancing my friend Alban has written a 2-part guest-post on one of the more important aspects of buying a home: financing.

Part 1 can be found here

Today in part 2 Alban looks at Fixed Interest Rates:

Note: This is US-centric article but those of us in the UK will still get a great deal of value from it. The UK mortgage market is mainly variable-rate offers. Fixed rates are available but longer terms are much harder to find than in the US.

Over to Alban….

Fixed Interest Rates

Many lenders will allow you to choose a fixed interest rate period which you are comfortable with and this could be from as short as one year, up to the full 30 years of your loan term. If you have taken a look at official interest rates and can see that they are at one of their lowest points then you could benefit from locking in a fixed interest rate on your loan to keep your repayments lower as well. Just keep in mind it is not always the best time to choose a fixed interest rate loan because official rates follow a cycle and may be low to encourage you to spend locally, however rates rarely stay low for very long and will be readjusted to standard levels.

Advantages of a fixed interest rate home loan:

  • Once you apply for and settle your fixed interest rate home loan rates will remain the same for the entire term we have chosen. This means that your repayments will also stay the same, allowing you to manage your budget into the future without having to worry you will need to dip into your emergency fund just to pay the mortgage. If you like to be able to accurately plan your finances, or if you need to stick to a tight budget then knowing exactly what your repayments are going to be throughout your fixed rate term can offer you the stability you are looking for.
  • Also because you are agreeing to pay a slightly higher interest rate in exchange for their monthly mortgage repayments you often need a lower down payment and rather than having to pay 10% or 20% deposit you may only need around 5% of the purchase price to secure a fixed interest rate loan.

Disadvantages of a fixed rate home loan:

  • If you decide during your fixed rate term that you want to refinance your home loan you can be charged much higher break costs to exit a fixed rate home loan than you would be on a variable-rate loan.
  • Also if you fix when interest rates are not at their lowest, when they start to decrease on their cycle then you will still be paying a higher interest rate and a higher loan repayment.

How To Choose A Fixed Interest Rate

Benefiting from a fixed interest rate home loan is all about making sure you fix at the right time. You want to fix when rates are at their lowest for when they have just started to rise from the bottom of the cycle. At the same time you need to make sure to shop around because each lender has their own opinions on how fast and how far interest rates are going to rise and fixed interest rate offers can differ significantly so take the time to find the lowest rate.

The term you choose depends on when in the interest-rate cycle you fix. Three to five-year fixed interest rate terms are often of the most benefit because if you fix for a shorter period than this you may be paying the higher fixed interest rate without seeing much protection from rises during this time and if you fix for longer you may miss out when interest rates begin to fall again. You can also choose a fixed interest rate term based on your circumstances and your future and you may choose a shorter to medium-term fixed rate until you have built up your savings account again after making your down payment on your loan, or until you are able to move ahead in your career.

Understanding the differences and benefits of both variable and fixed interest rates is just one part of your home loan comparison because you now need to look at your budget, your future and the interest rates on loans on offer from each lender.

Alban is a personal finance writer at Home Loan Finder, where he advise people on the best fixed rate home loans

Thanks Alban for guest-posting.

If you would like to offer a new perspective to Magical Penny readers do get in touch: adam AT

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