title. i understand the difference between variable and fixed as definitions however with loans, ‘variable’ doesn’t quite register to me..
why on earth would someone consider that type of loan with a purchase of let’s say, a house?
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let me break it down for you! Imagine you’re borrowing money to buy something, like a house. Now, a “variable loan” is like a special kind of loan where the interest rate, which is the extra money you pay back on top of what you borrowed, can change over time. It’s like the interest rate isn’t always the same; it can go up or down.
People might consider a variable loan because at first, the interest rate could be lower than a “fixed loan,” where the interest rate stays the same. This can make the monthly payments lower and more affordable in the beginning. However, the tricky part is that the interest rate can go up later, which could make your payments higher.
So, some people might choose a variable loan if they think the interest rates will stay low for a while or if they plan to sell the house before the rates go up. But it’s a bit of a gamble because the rates can change, and that’s why some folks prefer a fixed loan with a steady interest rate for the whole time.
It’s also not uncommon to break your loan into different combinations to offset that volatility in interest rates.
For example, having $100k fixed at 3% for 5 years and another $100k on a variable rate for 5 years and so on, minimises the impact when interest rates go up, as half your $200k loan is unaffected (because it’s fixed), and only the variable loan $100k is subject to those increases
Adjustable rate mortgages are easier to qualify for. Sometime it’s the only choice.
A fixed rate mortgage has a set payment throughout the whole time of the loan even if you choose to pay extra, the payment stays the same but the time is shortened.
An adjustable rate payment not only changes with the current interest rate but if you pay extra, the payment will go down but the time stays the same. You can also opt to pay the interest only if you’re short on money that month. You can even pay part of the interest if you’re really short but principle. [statement](https://modularhomeowners.com/wp-content/uploads/2012/12/mortgagepayment.png)
The idea is if you think that interest rates are currently high, you might get a variable interest rate loan so that you will benefit when they go down.
Sometimes you will get a small deduction on the initial rate and a lock in for a few years, so if you don’t plan to live in a house for more than a couple years it can benefit you.
From about 2010-2022 getting a variable rate loan was a very, very dumb idea (unless you were very sure you’d close it before the initial rate lock expired) because rates were incredibly low and the only significant movement possible was up.. which is what we’ve seen.
Getting such a loan now _may_ be a good time, as rates might go down in the future, but that’s not assured.
I have a 10-1 arm loan. First 10yrs are at ~2.5%. Year 11-30 varies based on inflation but is capped at ~7.5%.
Lower rate to start helped us have more overall purchasing power and get a better house. We’re about 2yrs in and plan to refi at some point or maybe we’ll just sell and move.
1. The interest rate is usually lower than that of a fixed rate loan/mortgage BECAUSE the rate can move up or down.
2. People choose them for that reason, and because the economic situation is relatively stable, so the expectation is that movement will be flat or downward.
3. The risk, as we are seeing now, is that the economy enters a sudden inflationary cycle, and the borrower either cannot “lock in” a fixed rate, or they do not do so quickly enough.
#s 1 & 2 favour the borrower, and that is why they take advantage of the option.
#3 is where “speculators” get into trouble and end up unable to make payments on their debts.
It’s all about how comfortable you are with risk. Until very recently, the variable rate mortgage fans were doing alright. But the last year or so has bitten many in the financial ass, and they will struggle to keep up, having taken on too much debt to be able to keep paying when interest rates move higher. That is why, in Canada, borrowers are required to pass a “stress test” which measures their ability to pay in the event of rate increases.
Central banks change interest rates all the time. Sometimes up, sometimes down. Down when the economy is bad, up when inflation is high and joblessness low (those two usually go together too).
Banks and large scale financing companies (like car companies finance divisions), borrow money from those central banks, and then lend the money to you at a markup.
So in the US right now, the US fed rate is 5.33, and you can get a loan from bank of America for about 8.5% as their prime lending rate (many loans will be prime + X where X depends on the type of loan and your credit rating).
Now where do variable and fixed come in.
If you want a loan for the next 5 years (or 25) years, do you think in that time interest rates will go up, go down or mostly stay the same?
To make money the bank will offer you a fixed rate which is higher than the variable rate (say 9.5% vs 8.5). This has the advantage of you fixing your cost. You know what the loan will cost into the future.
But if you get a variable rate, when the prime rate changes your loan changes with it. Interest rates go down, you pay less, rates go up, you pay more. That’s risky, but the benefit is that you pay a lower interest rate than if interest rates stay the same or go down over time.
In general variable rate loans are cheaper than fixed rate ones. Yes, it hurts really badly when rates have shot up as quickly as they have post pandemic, but interest rates haven’t been consistently this high in 20 years. (they were this high in 2006 and 2007 briefly).
Risk is a commodity like any other, and you pay for it. If I take a loan out at a fixed interest rate, the bank is accepting the risk that interest rates go up. They charge a premium for that. If I take a floating rate mortgage, they do not.
Short version: over the length of the mortgage – the floating rate mortgage will almost always be cheaper than a fixed rate mortgage. When interest rates spike, it will be higher.
I’m in the US, for reference. The most common mortgage here is a fixed mortgage. You can get a 30-year loan for a house today for around an 8% interest rate. That rate never changes for your mortgage.
With an adjustable rate mortgage (ARM), the interest rate is fixed a few years then starts adjusting towards the current market rate. If you get a 5/1 loan at 4% interest, you are guaranteed to pay 4% for the first 5 years. After that, the rate changes. It could go up or down depending on where rates are now. An ARM has caps on how much it can change each year and how much it can change over the life of the loan. For many ARMs, that 4% initial rate could rise as high as 9% eventually (the lifetime cap depends on the full terms of the loan).
I’ll share my history on mortgages.I bought my first house in 2000 at a 30-year fixed rate of around 8%. I refinanced a year later because the rate had dropped to around 6.5% for a 30-year fixed loan. My mortgage dropped by roughly $130 a month, which was well worth the cost of refinancing even though it had only been one year. The breakeven point was somewhere around one year, and I knew I’d be in that house for a lot longer than that, so it made sense. In the end, I saved 10k by the time I sold that house.
For my second house, I was moving to another state, and knew I would be there for at least three years but possibly much longer. I went with an adjustable rate mortgage because (at under 4%) it saved me $250 a month compared to the current fixed rate (5.5%). I ended up moving after 3 years. Even if I had stayed, the amount I had saved could easily pay for refinancing a new mortgage. Having an adjustable rate mortgage (ARM) worked out great for me – I saved about $9k in the three years I owned that house.
Bought my current house in 2017. Got a 30-year fixed mortgage. I refinanced it 2021, when rates were super low. I switched to a 15-year fixed mortgage with a interest rate of 2.25%. For comparison, the 15-year fixed rate today is just over 7%.If I had gotten a 5/1 ARM in 2017 when I refinanced it would have been around 4% interest. That would have started adjusting after 5 years, in 2022, and my rate today would be around 7%. My payment would have gone up by $550 a month. An ARM would have been an awful move for me in 2017.
ARMs only make sense if
* You’re planning to sell the house soon after the initial period (five years for a 5/1 ARM)
* You’re planning to refinance during the initial period
* You are willing to gamble that mortgage rates will stay mostly flat or drop
With an ARM, you’re taking a risk that rates may rise. If they rise enough, you could end up paying a lot more each month for your house.
Next, “why are variable rate loans even legal?”
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