Variable Rate Mortgage Advantages
A variable rate mortgage, fixed-rate mortgage or tracker mortgage is an unsecured loan application with an interest rate that varies according to an internal indicator that reflects the current cost to the investor of lending on the major credit markets. These loans are perfect for people who need a big cash injection in a few months but do not want to take on a long term commitment to a loan. Interest rates are also low on these loans. The advantage of the variable rate mortgage over a fixed-rate mortgage is that you can change the loan payment amount at any time by simply adjusting the interest rate and re-applying.
In contrast, a fixed rate mortgage is tied to the prime interest rate, the rate most likely to be charged on the most popular credit-based assets such as home equity loans and automobile loans. As a result, the variable rate mortgage has a lower interest rate than a fixed rate mortgage. If interest rates go up, so will the loan amount. Variable rate mortgages have flexibility as to how much the monthly payments go towards paying off the principal loan balance. These loans can also offer higher loan limits, allowing more money to go towards the principle.
However variable rate mortgages also have some disadvantages that you should consider before purchasing this type of loan. Some people believe that a variable-rate mortgage offers a lower interest rate than a fixed-rate mortgage. However this is not true and actually depends on the prime rate and some other factors such as bank fees and credit union rules. Some studies have shown that a variable rate mortgage has consistently outperformed a fixed-rate mortgage in the years since it was introduced.
If you are looking at taking out a variable rate mortgage you are going to encounter two major advantages and disadvantages. The first advantage is the flexibility of the loans. With a fixed rate mortgage you may only get one rate, for a certain term, while with a variable rate mortgage you may get different interest rates depending on how the market is performing. Also with a fixed rate mortgage you know exactly what you will pay and can budget your monthly payment to fit your budget. You do not have to worry about any unforeseen changes that could change the amount you will have to pay or the term of the loan. A fixed rate mortgage has the advantage of providing security; however if the prime rate goes up you could end up paying more than if the prime rate stayed the same.
The next disadvantage of a variable rate mortgage relates to changes in the availability of funds. With a fixed interest rate you know what the funds rate will be at any time; however if the markets go down you could encounter difficulty finding new lending institutions willing to finance your loan because of the lowered funds rate. On the opposite side when the market goes up you may not be able to find any new lenders willing to finance your loan. In this case you may need to cut back on some of the things you wanted to do with your home such as putting it on the market.
Overall both types of mortgage provide excellent home finance options but the variable rate loan seems to have the slight edge because of its flexibility and lower risks. It can be a good option for borrowers who want to take advantage of the current economic conditions while the fixed-rate loan offers a more secure base for long term use. If you decide to refinance there are several things to consider such as whether the lender allows credit checks to be done against applicants, whether they charge extra for a pre-approved loan, and whether there are any prepayment penalties for early payments. The best way to avoid these common pitfalls is to do your homework ahead of time.