Buying a house is a huge decision, and unless you have a lot of money saved up, you’ll likely need a loan to make that dream a reality. But with so many options, picking the right loan can feel a bit overwhelming. One of the first things you’ll have to decide is whether you want a fixed-rate or variable-rate loan. Don’t worry if these terms sound a little confusing right now – by the end of this blog, you’ll have a better idea of which one might work for you.

Let’s break it down, step by step, so it’s easy to understand and hopefully help you make a smarter choice when it comes to financing your home.

What Is a Fixed-Rate Loan?

A fixed-rate loan is exactly what it sounds like – the interest rate stays the same for the entire time you have the loan. Whether you’re paying it off for 10, 20, or even 30 years, that interest rate won’t change.

For example, if your fixed interest rate is 5%, it will remain 5% for the life of the loan. This is one of the reasons people like fixed-rate loans – they know exactly how much they’ll pay each month, and there won’t be any surprises.

Pros of Fixed-Rate Loans

• Predictability: With a fixed-rate loan, you always know what your payment will be, making it easier to budget. There’s no need to worry about interest rates going up and suddenly making your monthly payments higher.
• Stability: Even if the economy changes, and interest rates go up in the future, your loan won’t be affected. You’re locked into your rate.

Cons of Fixed-Rate Loans

• Higher Initial Rates: Fixed-rate loans might start with a higher interest rate compared to a variable-rate loan. This means that in the beginning, your monthly payment might be a bit more than what you’d pay with a variable rate.
• Less Flexibility: If interest rates go down, you won’t benefit because your rate is locked in. The only way to get a lower rate would be to refinance, which can be costly.

What Is a Variable-Rate Loan?

A variable-rate loan, also called an adjustable-rate mortgage (ARM), means that the interest rate can change over time. Usually, this type of loan will have a low fixed rate for the first few years, maybe 3 or 5 years. After that, the rate will change periodically, based on the current interest rates in the market.

So, if you start with an interest rate of 4% for the first few years, it could increase (or decrease) later, depending on the market conditions.

Pros of Variable-Rate Loans

• Lower Initial Payments: At the start, variable-rate loans typically have lower interest rates compared to fixed-rate loans. This can make your monthly payments smaller in the beginning.
• Flexibility with Market Changes: If interest rates drop, your loan’s interest rate can also drop, meaning you could end up with lower monthly payments after the initial fixed period ends.

Cons of Variable-Rate Loans

• Uncertainty: The biggest drawback to a variable-rate loan is that you don’t know what your payment will be in the future. If interest rates go up, your monthly payment could also rise, making it harder to plan your budget.
• Risk: If you’re not prepared for changes, a big jump in interest rates could make your payments too expensive, potentially causing financial strain.

How Do You Decide Which Loan Is Best for You?

When deciding between a fixed-rate and a variable-rate loan, it’s important to consider your own personal situation. Here are a few questions you can ask yourself:

1. How long do you plan to stay in the house?
   • If you plan on living in your home for many years (say 10 years or more), a fixed-rate loan might be better because you can lock in a stable interest rate and avoid the risk of rising rates.
   • If you think you’ll move in a few years, a variable-rate loan might save you money upfront with its lower starting rate. Since you’d sell the house before the variable rates kick in, you wouldn’t need to worry about future increases.
2. Are you comfortable with risk?
   • If the idea of your payments going up makes you anxious, a fixed-rate loan gives you peace of mind. You won’t have to worry about surprises.
   • On the other hand, if you’re okay with a bit of uncertainty and think you might benefit from possible rate drops, a variable-rate loan could be worth considering.
3. What is the current interest rate environment?
   • In times of low interest rates, locking in a fixed rate can be a good strategy, as rates might rise in the future.
   • When rates are higher than usual, a variable-rate loan might allow you to take advantage of lower rates later if they decrease.

Which Loan is Cheaper in the Long Run?

It’s hard to say definitively which type of loan will cost you less in the long run because it depends on a lot of factors, including how the economy performs and how long you keep the loan.

• If interest rates go up a lot in the future, a fixed-rate loan could save you money because you’d be paying the same amount no matter how high rates rise.
• On the other hand, if interest rates stay low or even drop, a variable-rate loan could end up being cheaper overall because your interest rate would adjust downward, saving you money on your monthly payments.

Other Things to Keep in Mind

Aside from just choosing between fixed and variable rates, here are a few extra things to think about when deciding on a loan:

• Loan terms: This refers to how long you have to repay the loan. Common terms are 15, 20, or 30 years. A shorter-term loan (like 15 years) will have higher monthly payments, but you’ll pay less interest overall. A longer-term loan (like 30 years) will have lower payments but more interest over time.
• Down payment: The more money you can put down upfront, the smaller your loan will be. This means you’ll pay less interest over time, whether you choose a fixed or variable rate.
• Refinancing options: If you start with a variable-rate loan and later decide you’d prefer the security of a fixed-rate loan, you might be able to refinance. Just keep in mind that refinancing can come with additional fees.

The Bottom Line

Choosing between a fixed-rate and a variable-rate loan isn’t a one-size-fits-all decision. It really depends on your financial situation, how comfortable you are with potential changes in your payments, and how long you plan to stay in the house.

If you prefer stability and predictability, a fixed-rate loan is probably your best bet. However, if you’re willing to take on a little more risk in exchange for potentially lower initial payments, a variable-rate loan could be the way to go.

No matter which option you choose, it’s important to fully understand the terms of your loan and how it will affect your budget now and in the future. Taking the time to think through these choices will help you feel more confident in your decision, making your home-buying journey a little smoother.