Variable Rate Mortgage Versus Closed Mortgage – What’s Right For You

For potential homeowners, arranging to pay the deposit is only half the battle. Then, they need to think about the different types of mortgage and what’s best for their specific buying situation. Buyers will need to choose between a variable rate mortgage versus a closed mortgage when purchasing their home. To understand what the right decision, they first need to know the difference.

Variable Vs Closed

Variable rate mortgages (VRMs), essentially mean that the interest rate is completely adjustable. It could change at any time without warning during your mortgage. Closed mortgages have fixed interest rates. Essentially, what you pay at the start of the mortgage will be the same throughout the closed period.

Interestingly, the difference between the two isn’t quite as massive as it first seems. Recently the difference between VRMs and closed mortgages has, no pun intended, been closing. It’s not at the point where it’s difficult to tell the difference between the two. However, home buyers shouldn’t make the mistake of thinking that their choice here no longer matters. It does, and the right decision will depend on factors that include lifestyle, income and how willing they are to take a risk.

VRMs are by far the riskier option. They regularly have lower interest rates compared to closed mortgages at the onset. Home buyers should not let this fact fool them, though. The danger is in the variation. Since variable rate mortgages can change without warning, there is no guarantee they will always be affordable. At a certain point during the mortgage, you could find the interest rate dire.

This makes closed mortgage rates safer yet more expensive. Interest rates are higher initially but unlike VRMs they won’t rise. They also won’t be reduced, and this is certainly a disadvantage. If the market improves, a VRM interest rate might fall. Closed mortgages will stay the same.

Which Is The Right Choice?

As mentioned, this is going to include the assessment of a number of different factors. To consider whether a VRM could be the right choice, home buyers must think whether they can afford an increase in interest. The first step they need to take is to look at their income. Are they in the position where there could be an increase in income in the future? Or, could they be in the position of making less money in the next few years. For instance, a freelancer will always find it difficult to handle a higher interest rate. Their income is not steady enough.

Before jumping on a VRM, buyers also need to look at the current state of interest rates. If they are quite low as they are now, it might seem like the perfect opportunity to invest and buy property. Using a VRM, you can get an initially great deal. While this is true, lower rates tend to mean that they will increase shortly.

Personality is another important factor when it comes to variable rate mortgages. People who constantly worry are not going to find this the best option. They will always be wondering when or if the interest rates will rise and that’s no way to live. Of course, there is a way to mitigate this type of situation.

The Best Situation For A VRM

A VRM will be best when home buyers can afford to pay a higher rate of interest. Ideally, buyers should pay the rate equivalent on a VRM that is the equivalent to a fixed mortgage. By doing this, they will have a lot of wiggle room if the rates do rise. They will also be able to benefit from the cheaper rates of interest in the future. It might seem like then there is no difference from a VRM and a closed mortgage. This isn’t quite true though because on a VRM you’ll still be able to access lower interest rates when you need them. That’s not possible on a closed mortgage.

Some people will try to get the best of both worlds by keeping a VRM when rates are low and switching to fixed when rates rise. On paper, this sounds like a brilliant idea, but home buyers must be careful. First, it’s very difficult to predict what on earth the interest rate is going to do from one day to the next. If you jump over too quickly, you might miss a major decrease in the interest rate on a VRM. At which point, you’re already locked into rate mortgage and paying more. If you start with a VRM, it might be best to stick with it.

Who Is The Ideal Candidate For A Closed Mortgage

The ideal candidate for a closed mortgage is someone who knows exactly what they are doing. In a closed mortgage, borrowers enter into a contract with terms and conditions. Borrowers agree to pay a set amount over a set period of time. During that time, home buyers will be expected to pay the exact amount. The benefit of this is that a homebuyer will have access to a fixed period of interest. However, they won’t be able to change the deal. So, if the homebuyer comes into money, they still won’t be able to pay off the mortgage faster, outside of any pre-determined pre-payment options, which have limitations. Outside of those pre-payment options, any incremental pre-payments will come at the cost of a penalty, which could be massive. Arguably, this is the biggest disadvantage of a closed mortgage.

The greatest advantage is definitely the consistent interest rate regardless of what's happening in the market. This makes these deals perfect for new, young homebuyers. They are generally on lower incomes and won’t be expecting massive rises in pay anytime soon. As well this, they could live in the home for ten years without looking for a change. The term will not be a major issue for them. In fact, a closed term mortgage could be a lot easier for them to manage.

Considerations To Make

It’s clear that there are a lot of considerations to make when choosing your type of mortgage. Personality, income, and knowledge of the housing market all play a part. Home buyers must analyze and assess all the issues before committing to any mortgage agreement. A mortgage broker can help guide clients through the various options and help determine what product is best suited to their lifestyle.