You’ve probably heard of fixed-rate loans and variable-rate loans. These are the two most popular options when it comes to mortgages, but what are they and what’s the difference?
If you’re new to the mortgage world, you might wonder what a variable rate loan is. In this article, we’ll run down the basics of what is and isn’t a variable rate loan and how to choose the best one for your needs.
Simply put, a variable rate loan is a type of loan in which the interest rate changes based on a set of pre-determined benchmark interest rates. Typically, these are the U.S. Treasury Bills, or the rates offered by banks or other large financial institutions. As the name would suggest, the rate can vary, so long as it remains within the stated range.
Since the rate is changing, the loan agreement is considered to be a contract, which means it can be modified or cancelled at any time. This is important to keep in mind if you decide to move or change your mind about the loan after making a deposit but before the end of the term.
Here’s how it works. Say you want to get a mortgage loan for a house. The mortgage lender will want to charge you an interest rate that is based on the rates of one of the following:
- the U.S. Treasury Bills
- the banks’ prime rate (the rate at which they lend to large businesses and wealthy individuals)
- the Federal Home Loan Bank’s rate (the rate at which they loan money to home buyers)
- the average rate of a selected group of large financial institutions (for example, all the big banks in the country)
- a rate set by an independent third party (for example, a credit reporting bureau)
With a fixed-rate loan, the interest rate is typically hidden in the contract and there’s no room for negotiation. If you decide you’d rather have a different interest rate, you’re out of luck. Your only option is to find a new lender or accept the rate as it is.
With a variable rate loan, however, the lender and the borrower can and often do negotiate the interest rate. In some instances, they may agree to a rate that is higher than the one stated in the contract. In other words, the rate can and often does change after the signing of the contract.
Key Differences Between Fixed-Rate and Variable-Rate Loans
Before you decide which kind of mortgage to apply for, it’s important to understand the key differences between the two. While both offer advantages, depending on your situation, one may be the best choice, while the other might be a bad idea. Let’s take a look.
With a fixed-rate loan, the rate is typically based on one of two things:
- the U.S. Treasury Bills
- the banks’ prime rate (the rate at which they lend to large businesses and wealthy individuals)
The advantage of this is that if you decide to re-finance or change your mind about the loan and ask for a different rate, the lender will usually give it to you. However, if you decide that you do not want to continue with the loan and it is not yet due, you have the option to cancel it. If you do decide to re-finance or change your mind about the loan after making a deposit but before the end of the term, the only option you have is to find a new lender or accept the current rate. There is no provision for negotiation.
With a variable rate loan, the rate is based on one of the following:
- the U.S. Treasury Bills
- the banks’ prime rate (the rate at which they lend to large businesses and wealthy individuals)
- the Federal Home Loan Bank’s rate (the rate at which they loan money to home buyers)
- the average rate of a selected group of large financial institutions (for example, all the big banks in the country)
- a rate set by an independent third party (for example, a credit reporting bureau)
- a rate negotiated with the borrower
- an index of some sort (for example, the S&P’s 500, the Dow Jones Industrial Average, etc.)
The advantage of this is that if you decide to re-finance or change your mind about the loan and ask for a different rate, the lender will usually give it to you. However, if you decide that you do not want to continue with the loan and it is not yet due, you have the option to cancel it. If you do decide to re-finance or change your mind about the loan after making a deposit but before the end of the term, the only option you have is to find a new lender or accept the current rate. There is no provision for negotiation.
When Should You Get a Variable Rate Loan?
As with most things in life, there are times when you should get a variable rate loan and times when you shouldn’t. You should get one when the interest rate is relatively low, as it is when the government is in the process of buying back or redeeming U.S. Treasury Bills. As soon as this happens, the prime rate (the rate charged by banks to their best clients) drops and mortgage rates fall with it. So, if you’re looking for an opportunity to refinance your mortgage, now might be a good time.
When the prime rate is relatively high, as it is now, mortgage rates do not always drop as soon as the government begins buying back its bonds. This is because even though the prime rate has dropped, the interest rate on mortgages remains the same. Only when the prime rate drops all the way to zero does the interest rate on mortgages drop to its minimum level.
For this reason, it’s usually a good idea to wait until the prime rate drops all the way to zero before you try to refinance or change your mind about the loan. Once it drops to this level, you will notice a significant difference in your monthly payments. This is because mortgage software, such as Quicken Loans’ LoanMagic, will automatically adjust your principal and interest so that your payment is at its simplest form. You won’t have to deal with extra fees or points when you refinance.
However, if you decide to get a variable rate loan even though the prime rate is still high, you’re making a huge mistake. While the rate may change during the life of the loan, it will not and should not drop to a level that is favorable to you. Instead, you’ll be paying more than you need to. So, while it’s tempting to get a variable rate loan with the prime rate being where it is today, you should really think twice before doing so.
What Is the Best Kind of Variable Rate Loan?
This is a personal choice. Just because one rate is variable does not mean that it’s the best choice for everyone. For instance, if you’re a company that deals with a lot of cash flow and need a lot of short-term cash, you may want to consider a 7/1 ARM. This is an acronym for the 7/1 adjustable-rate mortgage. This kind of mortgage allows you to negotiate a lower rate with the lender, since it has an adjustable rate that will change once a year, based on a published index (the 7 for 7/1 comes from the fact that the rate starts at 7% and can go as low as 1% or as high as 15%).
Another example of a good variable rate loan is the 10/1 ARM, which stands for 10/1 adjustable-rate mortgage. This type of mortgage allows you to negotiate a lower rate with the lender, since it has a 10-year term and will change once a year, based on the U.S. Treasury Bills or the Federal Home Loan Bank’s rate. This is a popular choice among home buyers who want to purchase a home in the next couple of years.
So, if you need a short-term loan or are in the market for a new home, you may want to consider getting a variable rate loan. Just make sure you’re getting the best rate that you can, since there is no negotiation with these loans.
Pros and cons of variable rate loan
When it comes to finances, there are certainties and uncertainties. One sure thing is that you will have to pay back the money you borrow, and there are a number of variables that can influence the total amount you will have to pay back. These variables are known as the ‘risk factors’ and can include things such as interest rates, repayment terms, and the creditworthiness of the borrower.
Risk Factors
The interest rate is always a key consideration when taking out a loan, and this is doubly so if you are looking at a commercial or mortgage loan. The risks associated with higher interest rates are pretty obvious – you will have to pay back more money over the life of the loan. Similarly, shorter-term loans with high rates of interest will have you paying back considerably more than the amount you initially borrowed. The interest rate alone is often not sufficient information for you to make an informed decision though; you should also consider the other risk factors.
Repayment Terms
The length of time you have to pay back the loan is another important consideration – the shorter the terms the lower your monthly payments and the more affordable your loan will be. The catch is that short-term loans usually come with high rates of interest, so make sure you are compensated appropriately for the additional risk you are taking on. As a general rule of thumb, you should aim to put together a repayment plan that will see you paying back your loan in a manageable amount of time – but not so long that you are struggling to make your payments. This is especially important if you are planning to pay off your loan quickly as the additional interest you will have to pay will negate any savings you make.
Creditworthiness
A good credit score will generally go a long way towards securing you favorable loan terms from reputable lenders. The reason why this is such a critical element of your funding plan is that bad credit can limit the amount of cash you can access, and it might even deny you the loan altogether. Even if you do happen to be approved for the loan you are seeking, the stipulations and conditions that your bank or lender lays down will put you under a lot of pressure to pay back your loan quickly. Having good credit means that even in case of default you will not be severely penalized by your bank or lender. Having bad credit means that even in case of default you could be forced into bankruptcy or face a hefty financial penalty.
The Benefits of a Variable Rate Loan
So, what can you expect from a variable rate loan? Well, for one thing, the rate will fluctuate which will, in turn, change the total amount you have to pay back. For instance, if you decide to take out a $10,000 loan at the then-current rate of 5 percent, you will have to pay back $5,000 over the course of one year. That’s $500 less per month than you would if the rate had remained constant at 5 percent and the loan had been repaid over 12 months. This is why it’s beneficial to take out a variable rate loan – the rates will change which will, in turn, change your monthly repayment amount and, thus, your budgeting requirements. It’s also important to look at the other side of the coin and consider the benefits that come with higher rates of interest and shorter repayment terms. The reasons behind this are quite simple – fees and interest are a necessary evil in today’s world and, if you compare lending institutions, you will almost certainly find that those with the lowest rates and longest repayment terms are the most expensive ones. This is why it is beneficial to take out a variable rate loan – the fees and interest are not as high as those of a standard loan, and, at the same time, you can make the most of this volatile market and get a lower rate than you would on a traditional loan. If you stay aware of the risks, you will be able to take advantage of situations such as these and, in the long term, will be better positioned to attain your goals financially.
What you’ll need to apply for a variable rate loan online?
If you’re looking to apply for a loan but don’t want to commit to a fixed rate, then you’ve come to the right place.
A variable rate loan is one in which the interest rate changes based on a number of factors. The main factor is the yield spread, which is the difference between the short-term interest rate and the long-term interest rate. The shorter the term, the wider the yield spread. The opposite is true for long-term loans.
Here are some of the most important things you’ll need to know before submitting an application.
The Difference Between Fixed And Variable Rates
As the name suggests, a fixed rate loan is one in which the interest rate remains the same for the entire term of the loan. Fixed rates are very popular because they simplify the process of applying for a loan. The drawback is that if rates change, you’ll have to reevaluate your entire financial situation and consider whether you want to continue renting or buy a home.
A variable rate loan is one in which the interest rate changes based on a number of factors. The most important factor is the yield spread, which is the difference between the short-term interest rate and the long-term interest rate. The shorter the term, the wider the yield spread. The opposite is true for long-term loans.
The main benefits of a variable rate loan are as follows:
- You are not locked into a contract, so you can renegotiate if rates change.
- You may qualify for lower rates because the lender assumes you’ll be able to afford the higher rates if rates rise.
- If you have a positive credit rating, then you may be able to secure better rates than others.
- It’s flexible – you can apply whenever you want
- If you’re looking for a home to buy, then a variable rate loan may be a good choice
On the other hand, the main drawbacks of a variable rate loan are as follows:
- The risk of losing money is higher because you have less protection against rising rates.
- You’re open to more unpredictable costs such as fees, prepayment penalties, and insurance policies.
- Variable-rate loans are more complicated to understand because there are so many clauses and conditions.
- It’s more difficult to save money for a down payment or closing costs when interest rates are rising.
- It’s more difficult to qualify for a mortgage if interest rates are rising because lenders have wised up and require larger down payments.
- If you’re looking for an additional source of income, then you may have to wait until rates drop before you can make a decent amount of money.
Which one you’ll choose depends on your situation. If you want to be able to quickly obtain money, then it’s best to opt for a fixed rate loan. Otherwise, if you want to be more careful with your finances, then a variable rate loan may be a better option. You can always apply for both and see which type of loan you qualify for.
How Long Does It Take To Process A Mortgage Application?
The application process for a mortgage is usually a time-consuming and tedious one.
Depending on the lender, it can take several days to a few weeks to process a mortgage application. During this time, you’ll have to provide as much information as possible and go through several rounds of review. It’s important to remember that the processing time varies from bank to bank, so you’ll have to find out what’s the typical time for your particular bank.
What Is The Best Way To Pay For A Mortgage?
The best way to pay for a mortgage is with a personal check or cashier’s check. Make sure that the money is available in the account before you sign the contract. If the check is post-dated, then so be it. Lenders often accept post-dated checks as collateral. Just make sure that the funds are available before the due date.
Another option is to open up a new line of credit with your bank. If you have good credit, then you may be able to get a low rate.
What Are The Various Types Of Mortgages Available?
There are several different types of mortgages available, each with their own set of pros and cons.
The most common is the fixed-rate mortgage, which we’ve already discussed. Another popular type of mortgage is the adjustable-rate mortgage, in which the rate is adjustable but must be renegotiated at the end of the term. Another type of mortgage, known as a pick-a-pay mortgage, allows you to make smaller payments each month until you eventually pay off the entire mortgage. Typically, these types of mortgages have a higher rate of interest compared to traditional fixed-rate mortgages, so be careful when deciding to go this route. Last, but not least, there’s also the military mortgage program, which provides special financing for active duty and veteran enlisteds looking to purchase a home.
Each one has its unique perks and quirks, so you’ll have to do your research before making a choice.
Hopefully, this article will help you figure out what type of mortgage may be right for your situation. Always consult with your financial professionals and legal counsel before taking any step. Remember, mortgage loans are a commitment to finance and may not be for everyone.
