Fixed VS Variable Rate Loans – Which Is Best?
When considering a loan, it is important to know the differences between fixed and variable interest rates. This tells you how the interest rates are calculated and the rate you will pay over the length of your loan. Understanding variable and fixed rates can help you save money and meet your financial goals.
What is a variable interest rate?
Loans with a variable interest rate are those that can change over time. The interest rate is only charged on the outstanding balance, not the initial loan amount, so whatever you have paid back will not be affected.
They are linked to an underlying benchmark or a financial index, so if the market changes, so will your interest rate. Because of this, variable rate loan payments will vary based on the interest amount, which can either go up or down depending on market conditions.
Related: What Are Interest Rates And What Do They Mean?
Which types of loans offer variable interest rates?
Taking out a variable rate loan can be more flexible in terms of initial cost but can fluctuate in payments over the time-period. Several types of loans feature variable interest rates, but the most common ones are:
- Mortgages: Called Adjustable-Rate Mortgages (ARMs). These are taken out when buying a house, and the interest rate usually changes periodically after an initial fixed period, such as 5-10 years.
- Credit Cards: Many credit cards have variable interest rates based on how much you spend and the rate that you pay on outstanding balances. This rate is often based on the prime rate set by your bank.
- Student Loans: Some private student loans offer variable rates that fluctuate based on the index.
- Personal Loans: Not many personal loans offer variable rates however some offer this for better options.
- Savings Accounts: The interest you earn on savings or paid in investments can adjust with market conditions and can either increase or decrease.
Related: What Credit Score Do You Need For A Mortgage
The pros and cons of variable rate loans
| Pros | Cons |
| Lower Initial Interest Rate: Typically, these loans start with a lower interest rate, making them better for short-term borrowing. | Uncertainty: Monthly payments and total interest can vary and rise unexpectedly, making it harder to predict long-term borrowing. |
| Potentially Lower Payments: If the interest rate decreases, your loan payments could go down, saving you money. | Risk Of Higher Payments: If the interest increases, your loan payments can increase. making it more expensive in the long run. |
| Short-Term Savings: If you pay off the loan quickly, you could save on interest rates before they increase. | Negative Impact On Credit Score: Rising rates can cause payments to be beyond affordability, leading to missed payments. |
| Flexibility: For certain people, variable rates offer flexibility from lower initial payments. | Harder To Budget: The unpredictability of rate changes can make it hard to plan. |
| Low Rate Offers: Some variable rate loans offer low rates or zero interest for some time. | Caps And Limits: While some have rate caps or offers, they still allow increases over time. |
What is a fixed interest rate?
A fixed rate, also known as a flat rate, is an interest rate that remains the same throughout the entire time you take out a loan. Whereas a variable one can increase or decrease with time, fixed rates mean that you pay the same interest during the term regardless of the market conditions. This makes it easier to predict payments and budget each month as what you see is what you get.
Related: Understanding The Difference Between Flat Rate And Compound Interest
Which types of loans offer fixed interest rates?
Like variable rates, you can find a range of loans and uses of fixed interest rates, including:
- Mortgages: Fixed-rate mortgages have an interest rate that remains the same for the entire term, which ranges from 15 to 30 years despite changes in the housing market.
- Auto Loans: Used to buy a car, auto loans are similar to mortgages and have the same interest rate throughout the loan.
- Student Loans: Government student finance often comes with fixed rates, meaning that it will stay the same from the day you take out the loan.
- Personal Loans: Most loans for personal use come with fixed interest rates, which help with predictable payments.
- Bonds and Annuities: Issued by governments or corporations, these come with a fixed interest to provide a guaranteed return, such as retirement or savings.
H2 – The pros and cons of fixed rate loans
| Pros | Cons |
| Predictable Payments: With the same interest rate, your monthly payments are consistent and easier to budget for. | Higher Initial Interest: Fixed rates often start with a higher rate, especially when interest rates are low due to the lack of change. |
| Protection From Increases: If the market conditions change, and interest rates rise, your rate will remain the same. | No Benefit From Decreases: On the other hand, if the market falls, you won’t receive lower interest rates. |
| Long-Term Stability: Fixed interest rates are ideal for long-term loans as you know how much you’ll pay, making it easier to plan. | Less Flexibility: Because of the stability, it means you’re locked into the interest rate even if the market changes. |
| Good For Expected Rises: Taking out a fixed rate loan when rates are expected to increase will shield you from these rises. | Expensive To Refinance: If you wish to switch to a lower interest rate, this may require additional fees and paperwork. |
| Easy To Understand: The same amount each month making it simple with no surprises. | Added Penalties: Some fixed rate loans come with fees for paying off the loan early. |
Can I change my rates?
Yes, this, however, depends on the type of loan you have, the terms of the agreement and your lender’s policies. It’s easier to change your rate from variable to fixed as some lenders allow you to switch, or you might have to pay a fee. Changing your rates from fixed to variable is harder as it’s more expensive to refinance, and you may also experience the risk of rising rates in the future.
To change your rates, you would either need to finance, which involves taking out a new loan to pay off your old loan or go through a loan modification. Either way, check with your lender to determine how they can help you.
Which is better: variable or fixed rates?
There isn’t one that is necessarily better than the other—it all depends on your personal preference and financial situation. Consider what you would prefer, whether you want a variable loan that offers flexibility or the stability and predictability of fixed loans.
Remember that interest rates aren’t all there is to the total cost of a loan. When deciding what is best for you, consider the following:
- Loan amount: Borrowing a large amount can result in higher interest rates as it’s riskier for the lender, whereas lower loans may have lower interest rates.
- Term length: Loans with longer repayment periods often have higher interest rates due to more monthly payments, whereas shorter periods have lower rates.
- Credit score: Borrowers with a higher credit score are seen as responsible lenders, so they can get lower interest rates, but those with a lower score can have higher rates as they are seen as more of a risk factor.
Read More: What Affects Credit Score?
To help, here’s a quick summary of the main differences between variable and fixed interest rates.
| Variable Rates | Fixed Rates |
| Monthly payments can change over time, increasing or decreasing with the market | Monthly payments are the same throughout the term |
| Initial interest rates start out lower, which can be favourable but can increase | Initial interest rate is usually higher but can end up being lower compared to the market |
| Best for short-term loans | Best for long-term loans |
| Higher risk as payments can increase | Lower risk as the rate is locked in |
| Benefits from falling rates | Doesn’t benefit from rate decreases |
To know how to decide, it’s best to check your eligibility for a loan and compare to find your best interest rate. At Sunny, you can compare loans with a range of lenders, so you know you’re making the right choice before you apply. For more information, check out our loan guides, or for tips on how to be money-savvy ,take a look at our Good Vibes blog.
