When you start your search to buy a home you are going to hear a lot about mortgage rates. You’ll either hear about how they are going up, that it’s great that they are going down, or possibly, why extremely low rates aren’t always a good thing.
Mortgage rates may be low currently, but there is still a big difference between 2.00% and 1.50%. The interest rate you pay is the fee that the institution you borrow from charges you for them to loan you the money upfront.
Interest rates are important to understand. When you buy a home, the down payment you have been saving for the last few years is only part of the equation. The interest rate affects your monthly payments. It also affects the total amount you will pay for your property. The purchase price is what your loan is based on, but the higher the interest rate, the more you will end up paying in the long run.
It’s important to understand your interest rate, whether the rate is fixed or variable. Even when rates are low, 0.5% can make a huge difference in the dollars that you pay over your entire mortgage.
What's the difference?
Fixed Interest Rates
The interest rate remains the same over the agreed upon borrowing period. In the example below, it is for five years.
Pro: Locks in your monthly payments and you don’t have to worry about economic shifts that might increase or lower your rate. This means you have stability and can lessen anxiety.
Con: If there is a big difference when compared to the variable rate, you may end up paying more over time.
If you want a set it and forget it mortgage then this is the rate for you.
Variable Interest Rates
With a variable rate mortgage the rate that you pay will change as the banks prime lending rate changes. Your mortgage payments will remain the same but the amount that is paid towards the principle of your mortgage will vary. Generally, variable rates are slightly lower than fixed rates because the institution is taking on less risk.
Pro: Historically, have proven to be slightly less expensive over time.
Con: Uncertainty. If rates rise significantly, your financial burden might become more than you can handle.
Choosing a variable rate in the short-term hoping to predict a rate drop so you can lock in at the right time could be a risky business. Rates can be hard to predict.
The difference interest can make
You may not think that half a basis point impacts your mortgage too much, but it can make quite the difference. In the example below, the last two scenarios compare how 0.50% can affect your mortgage payments and the amount of interest you pay in the short-term and the long-term.
In the calculator below, by paying 1.50% instead of 2.00%:
- The monthly mortgage payment decreases by $178.
- Throughout your 5-year term you will save $17,417.35 in interest.
- You save an additional $6,737.35 when your 5-year term is up.
- You will save $53,402.11 in interest throughout your 25-year amortization.
Fixed interest rate:
*This example is for illustrative purposes and is not intended to provide investment advice. The applicability and accuracy of the calculations are not guaranteed.
To find out exactly how big of a difference interest rates can make for you, use our mortgage calculator, or for an even better idea of how a mortgage can work for your specific needs, contact an advisor today.