“Fixed vs. Variable Interest Rate Loans”


If you are thinking about applying for a loan, you must understand the differences between fixed interest rates and variable interest rates. Whatever the reason you need this loan, understanding the differences between variable and fixed interest rates can help you save on money and achieve your financial goals.


Exhibit A: Fixed


‘Fixed’ interest rate loans are loans where the interest rate charged will remain fixed throughout that loan’s term. It makes no difference what market interest rates do either. This will lead to your payments being the same during the whole term. Whether this type of loan suits you largely depends on the interest rate environment when the loan is taken out. Moreover, it depends on the loan’s duration.


When a loan is fixed for its term, it stays at the current market interest rate, with or without a spread that is distinct to the borrower. For the most part, if interest rates are low, but will soon increase, then locking in your loan at that fixed rate is the best route to take.


Many homeowners go with the fixed rate option because they can prepare and budget for their payments. This is particularly handy for consumers with finances that are stable, yet tight. For them, it provides protection against potential rising interest rates that in turn could increase their loan’s cost.


Exhibit B: Variable


A ‘variable’ interest rate loan is where the interest rate charged on the outstanding balance varies with the changes in the market interest rates. The interest charged on this specific type of interest rate loan is connected to an underlying benchmark or index, like the federal funds rate.


Consequently, your payments will also vary so long as your payments are integrated with principal and interest. Variable interest rates can be found in credit cards, personal loans, mortgages, derivatives, and corporate bonds.


Generally speaking, variable rate loans have lower interest rates than their fixed counterparts. This mostly because they are a riskier choice in the eyes of consumers. Rising interest rates have the capacity to boost the borrowing cost, and consumers choosing variable rate loans need to be aware of the possibility of increased loan costs. For consumers who are in a good enough position to take the risk, or who aim to quickly pay off their loan, variable rate loans are the way to go.


Which one should I choose?


As simplistic as this discussion is, the explanation will not change one bit in a comparatively more complex situation. Studies show that, over time, the borrower is more likely to pay less interest as a whole with a variable rate loan in comparison to a fixed-rate loan.


Be that as it may, trends of the past aren’t exactly indicative of performances in the future. The borrower needs to take the amortization period of a loan into consideration. This is the total length of time it takes for a loan to be paid off. The longer a loan’s amortization period is, the greater the effect an alteration in interest rates will have on your payments.