Fixed versus variable mortgage interest rate – what is the difference in 2019
I’ve made a few videos discussing real estate investing as brick is a key component of one’s financial life. If you look at most people, a large chuck of their wealth is accumulated over the years by investing in real estate, be it their own home or other properties. So, taking a mortgage and buying a house seems the smart thing to do. But what kind of mortgage to take, a fixed or variable interest rate? That is what we are going to discuss today.
Here is the video for those who prefer watching or listening to reading, article continues below.
How to choose between a variable (adjustable) or fixed interest rate
Think of this first – you are making a 30 year long decision
– don’t make it on current news, make it on what might happen over the next 30
Variable and fixed interest rates – definition
A variable interest rate or adjustable interest rate changes
in relation to how market interest rates change. Your mortgage will probably
have an interest rate that is a bit higher than the interest rates set by the
Source: FRED – historical 30
– year fixed mortgage (red) rate and interest rate (blue)
Over the past decades, mortgage interest rates have always
been a few percentage points above the FED’s rates. What is important from the
above picture is that 30-year mortgage rates have also been above 13% for a
long period of more than 4 years in the 1980s, something to keep in mind before
taking a mortgage.
Fixed interest rate mortgage
If you don’t like uncertainty when it comes to your monthly
payments, you will take a mortgage with a fixed interest rate. That should not
change over the whole course of your mortgage but be sure to read the fine
print (ESSENTIAL TO DO THAT) so that if interest rates go back to 1980s levels,
you bank can’t trick you.
Current US 30-year, fixed-rate mortgage:
The negative side of the fixed-rate mortgage is that rates,
and thus the cost of your monthly payment is usually higher than with variable
rates. A bank has to insure against changes in interest rates for the next
30-years and therefore requires a higher rate.
Source: FRED – adjustable rate mortgage (blue) versus
30-year fixed (red)
There is not much difference between the adjustable rate and
fixed rate mortgage at the moment, but those things usually diverge by a
percentage point or more. The difference is cost globally isn’t much these
days. On 1 one percentage point difference, it is $50 on an $80k mortgage.
Now, which one is better? Let me show you my risk versus
reward investing perspective.
Variable or fixed: which is better?
So, for just $50 per month on a $80k loan, assuming you
bought a $100k home, you can sleep well because you are sure nothing will
change over the next 30 years. Adjustable interest rates in 2007 were above 5%,
average adjustable rates were above 6% during the 1990s and often above 10%
during the 1980s.
Now, let me put this into perspective. Let’s say you take
out a $80k loan, you take an adjustable rate of 3.6% on it. The rate remains
fixed over 10 years, but then, due to inflation, rates spike to 10%.
On an $80k loan, after 10 years you pay down only $15,626 of
your principal because you have to first pay interest on your loan.
Now, if interest rates spike to 10%, you still have 20 years
to return $64,374. The monthly payment at a 10% interest rate would be $732, or
47% higher than the current one. That is the risk for taking an adjustable
mortgage, you never know what lies ahead.
So, because of paying $50 per month more, or $600 per year
more, that is probably tax deductable in some countries so the difference is
even less, people choose for adjustable rates, not even thinking of what might
happen over the next 30-years.
In the current environment, where central banks will
constantly print money, I think it is crazy not to take a 30-year fixed
interest rate mortgage. But, then again, I always seem to be the crazy one.
Those that require higher mortgages, like to take adjustable rate mortgages to
have lower payments, they are probably buying homes they can’t afford.
ARM risky, should you go for 10 or 20 fixed years?
My thiking is why take a risk on something like a mortgage, any kind of risk? Given that mortgage rates are at historical lows. In the Netherlands, mortgage rates have not been so low for the last 500 years, the smartest thing to do is to fix the rate for 30 years. Given the difference in the monthly costs that is really small, versus the potential costs if interest rates go up, and those will likely go up as central banks print more money, it is much better to take a 30-year mortgage in the current environment.
But then again, people make decisions on whatever
assumption. On my stock market research platform, a subscriber asked me about
what mortgage to take in the Netherlands.
So, dig deeper into all kind of scenarios before taking a mortgage. Remember, it is a 30-year decision you are making! I am sure you didn’t go for one cup of coffee with your spouse and decided to live your life as she or he said. But, you are going to have a 30 minute chat with the nice mortgage officer, they will explain you what is the best option where they get the highest commission, and you will buy the house of your dreams.