Fixed vs Variable Mortgage: The Full 30-Year Guide

The short version

Fixed wins by $195,749.61 at the defaults: $400,000 borrowed, 30 years, fixed at 6.50%, variable starting at 5.75% and rising 0.50 points a year from year 6 to a 10.75% cap. The fixed payment is $2,528.27 a month, every month, for $510,177.95 of interest and $910,177.95 in total. The variable payment starts at $2,334.29 a month, passes the fixed payment in year 7 at $2,560.36, reaches $3,407.17 a month at the cap in year 15, and ends at $705,927.56 of interest and $1,105,927.56 in total. The cheapest loan here is a 15-year fixed loan at 6.00%: $3,375.43 a month and only $207,576.92 of interest.

The two payments at the start

The fixed payment is $2,528.27 a month and the variable payment is $2,334.29 a month, a gap of $193.98 a month in the variable loan’s favour. But the gap lasts five years and the loan lasts thirty. The fixed payment never changes, so $193.98 is the most the variable loan ever saves in a month. From year 6 the saving shrinks to $80.58 a month, when the payment is $2,447.69, and in year 7 it turns negative, when the payment becomes $2,560.36 and costs $32.09 a month more than fixed.

The math in plain words

Both loans use the same monthly payment formula: the loan times the monthly rate, divided by one minus one plus the monthly rate to the power of minus the number of months. For the fixed loan that is $400,000 times 0.065 divided by 12, divided by one minus 1.0054167 to the power of −360, which is $2,528.27 a month. The variable loan recalculates the payment each year on the remaining balance at that year’s rate. Add up every year’s interest and the variable loan costs $705,927.56 of interest and $1,105,927.56 in total, which is $195,749.61 more than fixed.

The year-by-year climb

The variable rate holds at 5.75% for five years, then rises 0.50 points a year: 6.25% in year 6, 6.75% in year 7, 7.25% in year 8, 7.75% in year 9, and 8.25% in year 10. The payments follow: $2,334.29 a month for years 1 to 5, $2,447.69 in year 6, $2,560.36 in year 7, $2,672.05 in year 8, $2,782.54 in year 9, and $2,891.59 in year 10. From year 15 on, the rate stays at the 10.75% cap and the payment falls slowly as the balance shrinks, but it never comes back near the fixed $2,528.27.

The break-even year

Year 7 is the turning point. At 6.75% the variable payment is $2,560.36 a month, the first payment above the fixed $2,528.27, by $32.09. Before year 7 the variable loan is cheaper every month; after year 7 the fixed loan is cheaper every month, and the margin grows: $143.78 a month in year 8, $254.27 in year 9, $363.32 in year 10, and $878.90 in year 15. Sell, refinance, or pay the loan off before year 7 and the variable loan has saved you money. Stay past year 7 and it starts costing you money.

When variable wins: the flat-rate case

Variable wins when rates stay low. If the rate never rises above 5.75%, the payment stays at $2,334.29 a month for all 30 years, the interest is $440,344.91, and the variable loan beats fixed by $69,833.04, or $193.98 a month for 360 months. Variable also wins if the loan ends early: the first six years at 5.75% save $193.98 a month against fixed, and the payment only passes the fixed one in year 7. The honest way to use the flat-rate case is as a question about your own plans: are you likely to move or refinance within six years, or are you buying the home you will live in for decades?

When variable loses badly: the fast rise

If the rate rises 1.00 points a year from year 6 instead of 0.50, it hits the 10.75% cap in year 10 instead of year 15, and the interest climbs to $762,838.34, which is $56,910.78 more than the 0.50-point rise and $252,660.39 more than the fixed loan’s $510,177.95. A faster rise punishes the variable loan twice: the payment jumps sooner, and the higher rate applies to a larger remaining balance. The fixed loan costs $510,177.95 of interest no matter what rates do. The variable loan costs $440,344.91 if rates stay flat, $705,927.56 if they rise 0.50 points a year, and $762,838.34 if they rise 1.00 points a year.

The 15-year alternative

The cheapest loan here is neither the 30-year fixed nor the variable loan: it is a 15-year fixed loan at 6.00%. The payment is $3,375.43 a month, $847.16 more than the 30-year fixed, but the interest is only $207,576.92, which is $302,601.03 less than the 30-year fixed loan’s $510,177.95. The catch is the payment: $3,375.43 a month is $847.16 more than $2,528.27, and that extra $847.16 has to fit the household budget every month for fifteen years. If it fits, the 15-year loan saves $302,601.03 of interest and the home is owned outright fifteen years sooner.

Three common mistakes

Mistake one: judging by the first payment. The variable loan’s first payment is $2,334.29 a month against the fixed loan’s $2,528.27, and $193.98 a month cheaper feels like a win. But the first payment is the cheapest the variable loan ever is: by year 7 it is $2,560.36, and over 30 years it costs $195,749.61 more. Mistake two: assuming rates will fall. The variable loan only wins if the rate stays flat at 5.75% or the loan ends before year 7. If rates rise 0.50 points a year, the variable loan costs $705,927.56 of interest; if they rise 1.00 points a year, $762,838.34. Mistake three: forgetting the cap. The 10.75% cap is the worst the rate can ever be in this model, and it arrives in year 15 with a $3,407.17 monthly payment. Before signing, check the budget survives the $3,407.17 cap payment, $878.90 more than fixed.

The bottom line

At the defaults, the fixed loan costs $910,177.95 in total and the variable loan $1,105,927.56, so fixed wins by $195,749.61. The variable loan is cheaper for six years, passes the fixed payment in year 7 at $2,560.36, and reaches $3,407.17 a month at the cap in year 15. If rates stay flat at 5.75%, the variable loan wins by $69,833.04; if they rise 1.00 points a year, its interest climbs to $762,838.34. A 15-year fixed loan at 6.00% costs $3,375.43 a month and only $207,576.92 of interest, the cheapest loan here if the payment fits.