In this post, we’ll explain how to choose a fixed or variable interest rate for your mortgage. Interest is the extra money you pay to your lender, in addition to your principal, as the cost of borrowing money.
Your lender will likely offer different options to determine the amount of interest you will pay.
Fixed interest rate mortgages
A fixed interest rate will not change during the term of the mortgage. These rates are generally higher than variable interest rates. This may be the better choice if you want:
- your mortgage payments to remain unchanged;
- to know in advance how much of the principal will be paid off by the end of the mortgage’s term;
- your interest rate to remain the same because interest rates will probably rise during the term of your mortgage.
Variable interest rate mortgages
A variable interest rate can increase and decrease during the term, and is often lower than a fixed rate. Interest rates fluctuate, so homebuyers must consider whether they would be able to pay a larger mortgage payment if interest rates rise.
A variable interest rate may be the better choice if you believe interest rates will not increase during the term of your mortgage.
A fixed payment with a variable interest rate affects how much of the principal a homeowner is paying off:
- If interest rates rise, you will pay more interest and less principal.
- If rates fall, you will pay more principal and less interest.
If the interest rate reaches a certain level, your lender may invoke a trigger point clause to increase your payment to ensure that you pay off the mortgage in its amortization period.
An adjustable payment with a variable interest rate alters your mortgage payment, as a specific amount of each payment applies to the principal. If the interest rate rises, your payments rise; if it falls, your payments fall.
Protecting yourself from interest rate increases
- An interest rate cap, which sets the maximum interest rate the lender can charge; or
- A convertibility option in which a homebuyer can convert the mortgage to a fixed interest rate. A fee, and possibly a higher interest rate, will be charged.
The interest rate you pay must be determined in consultation with your mortgage lender. If you desire, a real estate lawyer could review your mortgage terms with you to ensure that the mortgage is fair before you accept it.