What is the difference between fixed and variable mortgages?

When purchasing a home, one of the decisions you will need to make is whether you will have a fixed or variable-rate mortgage. There are key advantages and disadvantages to both options and it’s important to understand the differences between them before making your decision. This video will help you learn more about the factors you need to consider in order to ensure you choose the right mortgage for you.

Video transcript

When borrowing money to buy a house, you will have to pay the bank in the form of interest. The bank will offer different options on how this interest will be calculated. Which option is best for you will depend on your unique situation.

There are two main types of interest rates for mortgages: fixed interest rates and variable interest rates.

Fixed Interest Rates

Fixed interest rates stay the same for the entire agreed-upon term. This is usually between one and five years. Variable interest rates fluctuate depending on the market conditions, meaning they could increase or decrease during your term, but which is better depends. There are benefits and drawbacks to both. The main benefit of a fixed interest rate is predictability. You will be able to predict how much interest you will pay, making it easier to budget and make long-term financial plans.

A drawback of the fixed interest rate is that if interest rates go down and you have chosen a fixed interest rate, you won’t be able to benefit from this. Another disadvantage is that if you decide to end your mortgage deal before the end of the fixed term, you will have to pay what is known as a “break fee.”

Variable Interest Rates

Variable rates also have their advantages and disadvantages. Unless you have a crystal ball, you will never be able to predict what future interest rates will be. If interest rates go down, you will benefit by paying less. Alternatively, if they go up, you will have to pay more interest.

Variable interest rates are typically more flexible if you want to change your deal before the end of the term. If you choose a variable interest rate, you can choose between fixed and adjustable payments. With fixed payments, the amount you pay will remain the same monthly. If the rate goes up, a larger chunk of your payment will go towards interest, and if the interest rate goes down, a larger chunk of your payment will go towards your principal. With adjustable payments, your payment amount will vary with the interest rate. A set amount will go towards your principal; however, as the interest rate goes up or down, the amount of interest will vary, changing your overall amount paid.

Hybrid Mortgage

Lastly, you can choose a hybrid mortgage. This means part of your mortgage has a fixed interest rate, and part of your mortgage has a variable interest rate. Choosing between fixed and variable interest will depend on your situation, your market expectations and your risk aversion.

Speak to a financial professional to discuss which option is right for you.