If you are buying a home, or if you are refinancing your current home, you should consider a variable rate mortgage, sometimes known as an adjustable rate mortgage. It could save you money.
A variable rate mortgage is one where the interest you pay will go up or down based on the interest rate market. Usually a variable rate mortgage has a period at the beginning of the loan where the interest rate is fixed and does not change. A five-year period for a fixed rate is common, but there are loans with other lengths for the initial fixed rate. After that most variable rate mortgages will adjust once a year based on some public interest rate. For example the London Inter-Bank Offering Rate (LIBOR) is a common rate that represents the overall market for lending. On the appropriate anniversary your loan is re-set to the LIBOR rate plus or minus a percentage that is specified in your loan papers.
What is most important to you, the borrower, is that the initial interest rate on a variable rate mortgage is fixed and is generally a lower rate than a mortgage with a fixed rate for 30 years. That means your monthly house payment will generally be lower for the first five years. It is important, of course, to know the interest rates for variable mortgages and the comparable rate for a 30-year fixed rate mortgage so that you can compare them. Ask your banker to provide you with the principal and interest (P&I) payments for each combination of the length of the fixed period of the mortgage and any extra fees or points that they would charge you.
There are two reasons why you should consider a variable rate mortgage.
The first reason relates to how long you plan to live in the home. If you expect to live in the home for 5 years or less, it is almost always cheaper to have a variable rate. If you expect to live in your home for five to ten years, you will need to estimate future costs and make some assumptions about future changes in interest rates. If you expect to live in the home for more than ten years, you will likely be better off with a fixed rate 30-year mortgage.
The second reason is if you anticipate a reasonable growth in your income. A variable rate mortgage can ensure a somewhat lower monthly payment now, but even if the monthly payment grows after the first five years, your increased income will be adequate to make the payment.
A variable rate mortgage should be investigated to see if it can save you some money.