So you finally decided which home to purchase; now comes the "fun" part – Getting a loan.

One of the first concerns you should have as you are about to meet with the mortgage lender is "Which type of interest rate is right for me – fixed or variable"? Seems like a simple question, unless you have no idea what a fixed or variable interest rate is.

Both of these loan types refer to and are named after the actual interest rate being charged on your mortgage. The idea being one never changes and the other could and usually does change.

Fixed rate mortgage
The phrase refers to the interest rate of the note – Meaning it is fixed, permanent, non-changing for the life of the loan. So if you choose this type of mortgage, your loan payments will never increase.

Variable rate mortgage
The more popular loan type in Australia, this terminology also refers to the interest rate of the note and as you surmised, the interest rate can and will fluctuate. The actual interest being charged is based upon the financial index rate as listed with the Reserve Bank of Australia and then a certain predetermined percentage is added to this to figure the interest rate of the mortgage.

For example, if the prevailing index is 4%, your lender may add in another 0.5% to that making your rate 4.5%.

Generally the interest rate is amended over a staggered time frame – Say after the first year and then every three to five years after that. The occurrence of this is typically called the adjustment period.

Pros and cons of fixed and variable rates

Fixed rate pros

• Interest rate will never change over the length of the note regardless if interest rates go up or down.
• Payment amount (principal and interest) will not fluctuate ever.
• Security and stability offer peace of mind knowing your monthly mortgage payment is always the same.

If you are planning to stay in your home, a fixed interest rate is better over the long term. Especially if your loan is for twenty or thirty years, as a lot can happen during that amount of time.

Fixed rate cons

• If rates go down, too bad. If you want to take advantage of the lower rates, you will have to refinance. Only refinance if the interest rate is at least one percent lower than your current loan. Other wise it isn’t worth it.
• Have to refinance to take advantage of lower rates means paying closing costs again or rolling that into the new loan which eats up your equity.
• Monthly payments are higher meaning you may not qualify for the home you want.

• Initial beginning rate is very low making those first few years of home ownership easier to manage.
• If Interest rates go down, so does your payment freeing up some money and also means more of your payment will go towards the principal.
• Buyer can usually afford more home because the monthly payment is lower.

Variable rate cons

• If interest rates go up, so do your payments meaning you may have to sell if the rates go high enough making your mortgage payments out of sight.

Go for variable if you are planning to sell your home within four years of purchase or if you want to make accelerated payments so as to pay off the mortgage quicker.

Which one is right for you? Discuss it with your mortgage broker so they can give you more information to help you decide.

The real answer is simple – If you are concerned with the possibility of rising interest rates, get a fixed rate loan. If you are willing to "gamble" that rates will stay low, then get the variable rate mortgage.

Statistically over the last twenty years, variable rates have been lower than fixed rates in Australia. But, if inflation or a recession sets in, watch for interest rates to rise accordingly.

Just remember two things – Talk to your mortgage broker and you can always refinance if your payments are too high or if interest rates go down by more than one percentage point from your current loan.