Home Loan FAQ: What Is a Variable Interest Rate on a Home Loan?
Variable Interest Rate Home Loans
Much like vanilla and chocolate ice cream, home mortgage loans come in two main flavors: adjustable rate home loans, and fixed rate home loans. While the interest rate on a fixed rate loan stays the same throughout the entire life of the loan, an adjustable (or variable) interest rate loan can go up or down, depending on market conditions.
Should I choose a fixed or variable interest rate home loan?
While it’s hard to predict the market, if interest rates look low and you think they’re about to rise, it might be best to go with a fixed mortgage. But, if interest rates look high, and you think they might drop, a variable rate home loan could be a better deal. While some studies show that, on average, variable interest rate loan borrowers pay less over the life of their home loan, they are taking on significantly more risk.
Fortunately, though, you can usually “lock in” a specific interest rate for a certain period, often up to 10 years. Usually, the longer the lock period, the more interest you’ll have to pay. In fact, when people buy a house they know they’ll only want to keep for a few years, they sometimes sell it right before the lock period ends -- avoiding any hike in their interest rates.
What determines the interest rate of an adjustable-rate mortgage?
The rate of an adjustable-rate mortgage is determined by a market index, like the LIBOR or the prime rate. These are the rates at which banks lend money to each other on various money markets. That market index rate is added to the margin, or spread, which is the additional percentage cost added by the lender. This is how lenders make their money and guard themselves against additional risk.
Who is a variable interest rate mortgage best for?
We’ve already mentioned that a adjustable rate mortgage isn’t right for everyone, but who is it right for? Well, that depends. Usually, the best candidates for adjustable rate mortgages have serious cash reserves, great credit, and are confident that they’ll be able to sell or refinance their house if mortgage rates climb too high. Overall, getting a adjustable-rate mortgage can be a somewhat risky proposition -- but if you’re smart, you can often make it pay off.
What if I don’t like my adjustable-rate mortgage?
If you don’t like your ARM, you can always sell your home! But, aside from that, you can try to refinance your variable rate mortgage into a fixed-rate loan. While the rate you pay could be higher, you won’t be met with any unexpected surprises. Keep in mind, though, that it’s not always possible to refinance -- especially if home values fall and you lose a lot of equity in your home, or if you don’t have the best credit.