Having your mortgage application accepted is not the end of your home ownership process. Once accepted, you have to plan your monthly budget to ensure that you are able to cover your monthly mortgage payments as well as your needs. A fixed interest rate is more suitable than variable if you want your monthly payment to be the same all throughout your amortization period. This can help you set your budget more accurately. But if you opt for a variable rate, you will need to understand how the central bank’s interest rate hikes can affect you.
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Advantages of Variable Interest Rate
Before dwelling on its effects, it is worth knowing the pros of choosing variable interest rate over a fixed one. In previous years, there had been incidents wherein the rates dropped significantly to the delight of debtors who went with variable interest rates. Basically, you may also enjoy this advantage in the coming months or years.
The best part with this option is that when the interest rates are low, you may shift to a fixed interest rate for the rest of your amortization period. With the fixed one, you are not allowed to change into a variable interest rate when the rates are advantageous.
Disadvantage of Variable Interest Rate
The problem with variable interest rate is that you lack assurance. The factors influencing the interest rates are out of your control. Worst, you might end up paying a loan with a higher interest rate in the future. Private lending institutions are not always the ones that trigger the hike. It may actually be the country’s central bank.
Reasons Behind The Hike
Central banks usually impose interest rate hikes as a precautionary measure against risks of an economic crisis. In countries where there is a housing boom, the interest rates for mortgages are raised to help slow down the demand. Otherwise, too much debt can take a toll on the lending institutions and further result in a national crisis.
However, some experts also believe that the hikes may be implemented for the government and banks to generate revenues. They may impose them during the times when the expected interests are quite high due to the number of debtors.
Not all lending institutions are going to implement interest rate hikes the way the central bank intends to. If you have a loan with a variable interest rate, the amount you pay each month on your mortgage may remain the same. However, your lender will just adjust the amount that is considered as your payment for the interest rate and the amount for the principal. What you will see is that the percentage that goes for your interest increases while the percentage that goes for the principal amount goes down.
Your mortgage is one of the biggest loans you will incur. You should seek a mortgage broker to help you determine the type of interest that will suit your situation and spending habits the most. It also pays to know whether or not the central bank are introducing hikes in the coming months.
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