When we take out a loan, we will sometimes have a choice between a fixed rate and a variable rate. It is not always easy to decide which of these might be the best for us. It is therefore worth making sure that we have an understanding of what they are and the differences between then so that we can pick the one that suits our needs the best. You may decide to use a financial advisor who will be able to explain this to you. However, you may prefer to do the research yourself or you may not be able to afford the financial advisor. Below are some very brief explanations about what the two types of loans are and how to choose between them, which will help you to start the research process.
A fixed rate loan will have a fixed rate of interest and this means that your repayments will always be the same. The fixed rate could continue for the full term of the loan or it might be fixed for a certain time period and then become variable after that.
Many people like the certainty they get with a fixed rate loan in that they know exactly how much they will be repaying each month. They can budget and will not be affected by any changes in interest rate. This can protect them against increase but it does mean that if the rates go down then they will continue to pay at the higher rate.
If the loan moves onto a variable rate then this rate could be higher than other variable rate loans and so it might be sensible to switch to a cheaper lender. However, this may not be possible as with some fixed rate loans you get tied in to that lender for a certain time period. This can be a problem if you want to move to something cheaper even if you are in the fixed rate period so it is worth checking this. You may also be charged for paying the loan off early, which is what you will do if you change lenders as you will pay off the one loan with another. So, check this too before you sign up to the loan.
A variable rate loan can change its rate of interest at any time. This is likely to be when the prime rate changes, although some lenders will change their rates in between prime rate changes. As soon as the prime rate goes up, lenders are likely to increase the loan rates that are variable and you will end up paying more. However, if the rates come down, they may lower them. They do tend to be slower to respond to a decrease than an increase though.
There is less certainty with this type of loan as you can never be totally sure how much you will be paying each month. This might be a problem if you have a very tight budget but if you can be more flexible then it may not be.
Which type of loans suits you the best will depend on your financial situation. If you struggle to budget each month, then it would be sensible to take a fixed rate loan so that you know how much you will be paying. Choose a loan with repayments that you will be able to afford. If you have more leeway with your budget then you may feel happy to have a variable rate. You might feel that you would rather have the opportunity to have a reduction in your interest rate and risk the rate going up rather than being tied into a fixed rate. You may not like the idea of being tied into something which you cannot change.
It can also be wise to think about whether rates are likely to go up or down. A fixed rate loan will protect you against increases in the rate. It can be hard to predict whether the prime rate will go up or down, but you may be able to make some estimates. If it is low, for example, it is more likely to go up than down. Listen to what economists and politicians are saying about the economy and what might happen. No one can predict precisely though so try to avoid taking a risk but weigh it up sensibly. You might be able to change lenders anyway if you feel that yours is not competitive. However, you will need to check carefully as some will have extra charges if you decide to switch lenders, so find out before you take out the loan. If you cannot see it easily then you should be able to contact their customer services department and ask them.