# How to Choose Between a Fixed or Variable Rate

Have you ever wondered which one is better: a fixed or variable rate? You might think that a variable interest rate is the best option always, given that a variable interest rate is one that is variable, meaning that it can change over time.

A fixed interest rate, on the other hand, does not fluctuate over time. You’re locked in.

We often talk about variable and fixed interest rates when we talk about loans. A loan is a debt provided by one organization or individual towards another organization or individual. Generally in a loan, assets are reallocated between the lender and the borrower. So if tomorrow I woke up and felt like buying a car I could go to the bank or auto dealership and ask for a loan; \$20,000 to buy a car. They might say no, but the point is I could ask. Likewise, I could wake up tomorrow and say to myself “I’d like to live in a house”, and go to the bank and ask for a mortgage loan, wherein I would borrow money to buy some property.

A loan is a form of debt instrument, or security.

A security in the world of finance is a financial instrument that is fungible, (one security can be replaced by another) negotiable and represents some sort of financial value.

## The Main Culprit: Mortgages

In the event that my mortgage loan is passed, I’m now left with the task of paying back that \$200 or 300k. A loan then, is when a borrower (me) receives or borrows some money (the principal) from the lender (the bank) and is required to pay back that money to the lender (the bank) at a later date.

I don’t just pay back an equal amount to the bank. For the privilege of borrowing that money I have to pay interest. The interest I pay on a loan is basically the fee I incur for “renting” the bank’s money.

The interest rates on the mortgage loan can take the form of a fixed or variable interest rate.

So I’ve made it to the bank. I know just the type of house I’d like to live in: 3 bedrooms, with a front yard and swings in the back yard. Modern, but also rustic. My loan officer informs me that I have to choose between a fixed or variable interest rate on my 25 year mortgage loan.

Look, a bank generally has two avenues from where it sources its money. One is from its clients. The other is the government. Investment banks may have other sources of capital but for simplicity’s sake let’s just use these two. When a bank gets money from the government it pays some sort of interest rate. They then turn around and charge consumers and potential home owners like me higher interest rates, making a profit of the difference.

## Economic Trends

Interest rates are always changing. In times when the economy is hurting, money is made available to banks by the government at very low rates. They do this in order to incentivize banks to make capital available to those that need it at cheap rates.

Now if this was the economic climate that day I walked into the bank looking for a mortgage loan it might make sense for me to take a fixed interest rate.

If the economy is roaring, and money is drying up then I might make a different choice. In this world, we are in the middle half to tail-end of the economic cycle. Interest rates are higher as there is less and less capital available. A 25-year mortgage loan is offered at 7.3%.

Wow. At that rate a \$250,000 loan would cost me an extra \$275,311 over 25 years. Were I to pick a fixed interest rate at this moment in time then I would be locked into that 7.3%. This could turn out to be a mistake. Given that we are in the middle to last part of the economic cycle I could conceivably expect interest rates to go down. If I picked a variable interest rate instead I would benefit when interest rates declined. I might pay 7.3% for the first year or two but that would steadily decline until I’m paying 5%, 4% or even 3.5%.

That makes a huge difference. Over 25 years a \$250,000 loan would cost me \$124, 452 in interest at 3.5%, nearly \$150,000 less than at the higher interest rate.

On the other hand, if we’re making this decision at the beginning of the economic cycle and I’m presented with a 25 year mortgage rate of 2.7% then I might be inclined to take a fixed interest rate. At 2.7% over 25 years my \$250,000 loan would only cost \$93,490.

So really the answer to whether or not you should pick a variable or fixed interest rate is: it depends.

## Back to the Future

Looking at history it would be easy to judge what you should have done. When interest rates are low and were about to shoot up, you would have picked a fixed rate and if interest rates were high you would either wait it out or pick a variable interest rate if you absolutely needed that house right that instant.

This is a simplistic explanation of a complicated topic but hopefully it shed some light. It is good to know that many academic studies have actually found that a borrower is likely to pay more interest when using a fixed rate loan versus a variable rate loan. Dr. Milevsky of York University examined mortgage interest rate data from 1950 to 2007 and found that choosing a variable interest rate loan would have saved would-be homeowners \$20,000 over 15 years.

When making the decision between fixed or variable it is always important to consider the amortization period – the total length of time it will take you to pay the loan – as the longer the amortization period the greater impact changes in interest rates will have on you. A sudden change today will have ripples that permeate throughout the entirety of your contract.

January 2, 2021 Update: We have just announced our BEST STOCK NEWSLETTER of 2020 AWARD!

CLICK HERE to find out which stock newsletter was up 78% in 2020 (and whose 2019 picks are now up 113%).

## *** Our Award for BEST STOCK NEWSLETTER of 2020 ALERT ***

### Updated January 2, 2021

At WallStreetSurvivor, we subscribe to dozens stock recommendation and advisory newsletters. There is ONE newsletter that is constantly outperforming all of the others--The Motley Fool Stock Advisor.

Five of their 2020 stock picks have doubled and the average return of all 24 of their stock picks for 2020 is up 78%!

We have been tracking ALL of the Motley Fool stock picks since January 2016. That's 5 years and 120 stock picks. As of Friday, January 1, 2021 the Motley Fool's January stock pick (TSLA) is up 720%, their March pick (ZM) is up 172%, their April pick of SHOP is up 226% and their June pick CRWD is up 120%; and another two have more than doubled. In addition, 10 of their 2019, 12 of their 2018, 11 of their 2017, 15 of their 2016. Most impressively, over the last 5 years that we have been tracking every recommendation, their average stock pick is up 209%--tht means over the last 5 years their stock picks, on average, have TRIPLED!

Now no one can guarantee that their next picks will be as strong, but our 5 years of experience has been super-profitable. The important thing about the Fool stock picks is you have to buy them the day they are recommended because they usually pop 5-10% in the first 72 hours after the release their recommendation. You sure don’t want to risk missing out on their next pick.

Normally the Fool service is priced at \$199 per year but they are currently offering a NEW SUBSCRIBER DISCOUNT that allows you to get theiir next 24 stock picks for just \$99/year. HERE is the LINK to visit their New Subscriber Discount page.

CLICK HERE to get access to all The Motley Fool’s Stock Picks and their next 12 months of picks for just \$99 per Year!

### GET UP TO \$1,000 IN FREE STOCK

##### WHEN YOU OPEN A ROBINHOOD BROKERAGE ACCOUNT

Robinhood was the first brokerage site to NOT charge commissions when they opened in 2013. They just past 10,000,000 accounts and to celebrate they are offering up to \$1,000 in free stock when you open a new account.