Loans are a valuable aid and a very important financial tool to use. Whether it is to go to school, buy a car or even buy a house, loans are often necessary to achieve these goals. The fact is that most people do not have thousands and thousands of dollars to pay for these things in cash, so loans can save lives. Fortunately, loans are quite affordable today compared to 10 years ago, making approvals easier than ever. Plus, with many lenders offering loans, there’s no shortage of places to research and choose from. So while getting a loan today may be easier and better than ever before, you still have some tough choices to make. Of course, you have to choose where to get your loan, etc., but one of the most important choices when it comes to borrowing is to choose between a fixed rate loan and a variable rate loan.
I hope this article will help you make that decision as we look at what these loans are, the pros and cons of each, and more.
What are fixed and variable loans?
Before we dive into the pros and cons or start looking at what works best for you, we need to explain what makes a loan fixed versus what makes it variable.
A term loan is a loan where the interest rate will remain the same for the duration of your term, regardless of market fluctuations. This means that your monthly payments over the term of your loan will remain the same.
A variable loan, on the other hand, is one in which the interest rate will fluctuate throughout the life of your loan. How the rate changes over the life of the loan will depend on current market conditions.
Advantages and disadvantages of fixed and variable loans
Now that you know what constitutes a fixed rate loan and a variable rate loan, let’s look at the pros and cons of each and the main differences between the two types of loans.
- Offers much more stability (monthly payments are always the same).
- If your credit score is good, you may be able to get a very low fixed rate.
- Not everything that happens in the market will dictate how much you pay.
- Usually easier for beginners because you don’t have to monitor them as much.
- If interest rates go down, you won’t benefit unless you are able to refinance.
- The rate on fixed loans is often higher than on variable loans.
- If rates ever go down, you’ll miss out on some of the savings.
- Often cheaper over time and currently have lower rates.
- They are more flexible and may contain additional features and benefits.
- There can be a lot of uncertainty because the rate and payments will fluctuate.
- If interest rates go up, your payments will go up too.
- Can be more complicated to understand and requires monitoring.
- As you can see, both types of loans are good in some ways and bad in others.
Which is better?
Of course, the best type of loan will depend on many factors. The first and most obvious factor is the current market and the current interest rate. If the variable (market) interest rates and the fixed interest rates offered by providers are close, it is often wise to choose a fixed mortgage. You will get a similar rate without the risks associated with a variable rate loan. If the difference is large, it makes sense to use a variable loan, even if the rate increases slightly, you still get a good deal.
In addition, you should also take into account the market trend. If you think interest rates will go down, opt for a variable rate loan, because your rate will go down with the market. However, if you think they will rise, opt for a fixed rate.
What is most important to your current lifestyle?
Another factor to consider is the degree to which interest rate stability and predictability is valued. If you want your payments to always be the same, you may be willing to pay a premium for a fixed rate loan to ensure your payments are not always the same. If you’re a bit riskier and agree to fluctuating payments, a variable rate loan will work for you. Variable loans seem to be better for the risk-taker because there is a real battle between risk and reward, whereas a fixed rate loan won’t change as long as you have it.
Another thing to consider is your overall financial situation and the amount you need to allocate to these payments each month. If you have enough to “weather a few storms”, you’re probably more willing to take the risks inherent in a variable rate loan. If you’re struggling a little and can’t handle an increase in your payments, then go ahead and take out a fixed rate loan because your payments will be consistent and there will be no surprises.
Is predictability important?
In general, fixed-rate loans are best suited for those who prefer the predictability of regular monthly payments, can expect low interest rates and are confident that interest rates will rise over the next few years.
Variable rate loans are advantageous for people who are more comfortable taking risks, are not afraid of inconsistent payments and believe that interest rates will fall from their current levels.
Whatever you choose, make sure you’ve thought about it carefully. Remember that having a loan is extremely helpful and is a good thing, but being stuck and not being able to pay it back is not. So be careful and make sure that the loan payments for which you are responsible are well within your means. Before you decide to start a loan and choose variable or fixed, it’s a good idea to do some research and take a step back to make sure you make the right choice based on your current financial situation and needs.