Fixed vs variable rate loan
originally posted: 11/22/2006 reposted: 2/18/2011 This post has not been recently reviewed or revised by the author and may be out of date. If you notice an error or are in doubt, please send a new question by email or ask for an update. Email asktony@tonynovak.com.
Q: I am refinancing my house but have not decided whether to use a fixed rate or variable rate loan. The variable rate loan is offered at 4.9% and the fixed loan at 5.6%. Shouldn’t variable loans be a much lower rate over the long term?
A: You are not alone in your confusion about interest rates. Even Federal Reserve Chairman Alan Greenspan admitted being puzzled yesterday. Yes, a variable rate loan should usually result in a lower overall interest expense than a fixed rate loan. But in today’s market the fixed rate loans are offered at almost the same price as variable rate loans, so it does not cost much extra for the guarantee that rates will not rise in the future. This is because long-term interest rates are about the same as short-term interest rates. One way of looking at it is that “interest rate guarantees” are now offered at record low prices. This situation is called “flat” interest rate yield curve and usually means the economy is headed toward a slowdown. In our present situation, however, it might simply be a reaction to the recent hikes in short term interest rates. But in a healthy economy over the long term, long-term interest rates should be higher than short-term interest rates. This means that if you are borrowing with the ability to pay off or refinance in the short term, you will benefit by using variable rate loan.
Summary
More resources:
resource list goes here