Variable vs Fixed Rates: What’s Best in 2022?

Fixed interest rates

It’s 2022 and the financial world has become less predictable than ever. While the Covid-19 crisis is mostly over, its economic aftermath lingers on. This includes supply chain issues that are affecting the construction of new homes and inflation. Both issues seemingly have contributed to specific market conditions where home prices have increased by 30% or more in some regions in the past year alone. Despite the increase in pricing, the public’s interest in buying property has yet to decline.

Inflation rates have grown wildly across the globe, As part of the Federal Reserve and the U.S. Government’s plan to tackle rising inflation, interest rate hikes have been introduced. So far the Fed has increased interest rates from 0.25% on average to 1% and there is a chance it’ll rise a bit higher.

The Fed Chair, Jerome Powell recently unveiled his plans to combat inflation. In a recent discussion with the press, he claimed that he’d continue raising interest rates until inflation subsides:

“If that involves moving past broadly understood levels of neutral we won’t hesitate to do that,” the central bank leader told The Wall Street Journal in a livestreamed interview. “We will go until we feel we’re at a place where we can say financial conditions are in an appropriate place, we see inflation coming down.”

“We’ll go to that point. There won’t be any hesitation about that,” he added.

Interest Rate Expectations in 2022 & Beyond

Despite Chair Powell’s claim, it seems unlikely that the Federal Reserve will raise interest rates much higher. Over the past 10 years, the average interest rates were typically 0.25%. The highest interest rate seen in the past decade was 2.25% and that was only for a short period of time in the years 2018-2019 before being cut back to 0.25%.

By raising interest rates too high too quickly, the Fed could cause chaos in the U.S. stock markets. This could worsen the U.S. economy in turn. As the interest rates have risen, we’ve been witness to declines in both the S&P 500 and Nasdaq. The S&P 500 has already lost 13% since the start of the year. Should the stock markets decline further, this could lead to large public companies cutting staff and unemployment rates increasing. Such a move could worsen the U.S. economy and cause a sharp recession.

The economist Desmond Lachman, shared concerns regarding the Fed’s policy and its potential outcomes on CNN Business. Lachman stresses throughout the article that the Fed’s monetary policy affects the U.S. economy with a lag. In addition to that, an aggressive policy could do more harm than good.

Should the Fed adhere to Lachman’s warnings, it seems that interest rates may continue to rise slightly but at a slow pace and with extra attention to the economy.

Interest Rates & the Housing Market

The housing market in the U.S. is directly affected by the Federal Reserve’s policy. According to the US Census, the percentage of homeowners’ mortgage is 64.8%. This number may have increased a bit recently along with housing prices.

As housing prices increase, a consumer may have less funds to cover the full costs of a home with cash. As such we may see an increase in mortgage application rates even with the Federal interest rates increasing.

On the other hand, increasing the interest rates will affectively cause mortgages to become more expensive. As interest rates rise, so will the amount a new mortgage applicant will need to pay back on a monthly basis. It will also affect homebuyers who have purchased a home with a variable rate mortgage. This could encourage some homebuyers who can afford it to make a cash purchase, and discourage others.

Hypothetically this may cause a bit of a cool down in some local real estate markets. It is a bit too early to say at this stage, however.

Variable Rates vs Fixed Rates

The world of mortgages is mostly split into two categories. Fixed rate mortgages and variable rate mortgages, which is sometimes also called a floating rate. As the name implies, fixed rate mortgages have a fixed rate which is decided at the time of application for the full term of the mortgage. Fixed rate mortgages typically have slightly higher interest rates but come with the guarantee that the borrower will pay the same amount every month.

Variable or floating rates, on the other hand change periodically depending on the Federal interest rates in most cases in the USA. This usually is stated in a mortgage as: “variable rate at 5.5%” or in other words “US prime rate + 1.5%” as an example. As the Fed increases interest rates, the amount required to pay back monthly with a variable rate will increase. Typically the rates change once per month or whenever periodically stated in the mortgage contract.

In many cases variable rate mortgages cost the consumer less than a fixed rate, but the borrower accepts the risks that rates may change. Sometimes that change is in their favor, and other times it isn’t.

What Mortgage Works Best in 2022?

It is exceedingly difficult to anticipate what lurks around the corner in the current world of finance. We’ve already seen quite unusual economic circumstances in the past year or two. Should things settle down a bit and the world return to relative normalcy, it would be a bit easier.

If the Fed will listen to Lachman’s advice, we may be towards the end of major interest rate hikes. As such a variable interest rate mortgage with good terms may be better for most consumers for the foreseeable future. While fixed rate mortgages may suit the more cautious types, their rates tend to be much higher on average than a variable rate.

That being said, in a year or so, the Fed may need to cut rates in order to stimulate the economy once again. This hypothetical situation could be very much in the favor of those who have applied for a variable rate mortgage.

The only thing that is certain at this point, is those who have applied for a mortgage in 2022 may want to consider refinancing it in a few years.

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