The difference between variable interest rate and fixed interest rate mortgage

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 There’s a high chance that before considering a mortgage application you have heard the terms ‘variable interest mortgage’ and ‘fixed interest mortgage’ at least a hundred times but it never really piqued your interest.

Now you want to know as much as possible about various types of mortgages and how can they work for you. Welcome to the wonderful world of financial jargon.

As you may already know the mortgages are in vast majority comprised of only two parts: the capital, which is the selling price of property and the interest, which is the amount bank earns over the whole period of your loan.

While the capital is very straightforward – it’s simply the negotiated price of property which mortgage covers, the interest can come in many flavours and lenders are offering customers a few ways to apply it depending on their financial circumstances and lifestyles. Interest rates tend to change on a monthly basis depending on various factors including the economy, situation in banking sector and lender’s business needs.

While in most cases the fluctuations are not very significant, the monthly repayments can clearly reflect major changes like, for example, the proposed increase of base interest rate by the bank of England. In order to provide more peace of mind and control over budget, lenders introduced fixed rate mortgage loans which freeze the amount of monthly repayments on one level typically for two to five years.

Photo by Adrian Short

You don’t really come across longer terms for fixed rates because it’s difficult to forecast the financial situation any further than five years ahead. Fixed rate loans are more expensive that their variable rate counterparts but offer protection against rapidly changing rates and give consumers the chance to plan their budget more accurately.

It’s also worth noting that this type of loan has higher applicant requirements, which means that if your financial circumstances are not that great, you may be refused fixed interest but accepted for variable interest mortgage. Variable interest mortgages are less expensive in the initial period of time; lenders are often setting preferential interest rates for the first couple of years which leaves home buyers with extra cash to spend on their new property.

It’s also a popular option with customers who take a mortgage loan and hope to increase their annual income before the initial period ends and the rates rise. It’s certainly the more popular type of mortgage since the applicant requirements are lower than in case of fixed rate but keep in mind that variable interest loans may not be eligible for refinance during the first couple of years, or may require very high exit fees in order to remortgage.

High penalty fees make the whole process rather pointless considering the potential savings from refinance.

The choice of one or another boils down largely to currently applicable interest rates, applicant’s financial circumstances and lifestyle choices. Some people will appreciate the security fixed rate offers while others will go for variable rate in order to fully take advantage of favourable situation in mortgage market.

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