The difference between variable and fixed interest rate loans.
While it’s important to look for loans with low interest rates, it’s also important to understand the difference between fixed and variable interest rates. This is particularly true if you’re borrowing large amounts of money, such as when taking on a mortgage. Each option has its benefits, and in this article, we’ll take a closer look at both, as well as which may suit certain types of borrowers better.
Fixed rate loans.
A fixed interest rate essentially means that the amount of interest payable over the duration of a loan will be ‘locked’ for a certain period of time. This is typically between one and five years, after which the interest rate will either revert to a variable rate or switch to a new fixed rate.
A key benefit to a fixed interest rate is that borrowers have a very precise idea of how much interest they’ll need to pay over a set period. In addition, fixed interest rates provide insulation against any loan interest rate increases, whereas variable rates will increase. This can be a great way to protect against economic instability, allowing borrowers to continue paying a set rate for the duration of the fixed period, no matter how high variable rates climb.
These benefits can be invaluable if you’re on a tight budget, as there won’t be any unexpected fluctuations that may create unplanned financial pressure. It’s worth keeping in mind, however, that some fixed rate loans lack the flexibility of variable rate options, such as the ability to make additional repayments and get out of debt sooner.
Variable rate loans.
On the other side of the coin, variable interest rates can be volatile, meaning there’s more chance of increases or decreases in the amount of interest payable. This could mean the amount you have to pay monthly increases, but it also introduces the possibility of your interest rate going down, allowing you to save money.
The core benefit to variable rate loans – particularly when it comes to mortgages – is flexibility. These types of loans typically come with all sorts of different features that make it possible to pay off your debt quickly, including the possibility of making additional payments and the ability to create an offset account, which reduces the overall interest payable. If you take advantage of these features when the variable rate is low, it’s possible to pay off a loan much more quickly than with a fixed rate, ultimately saving money in the long run by limiting the accrual of interest.
The most important thing to keep in mind when selecting a variable rate loan is that your payment may change if there is a change to your interest rate. As such, it’s important to ensure you’ll be able to meet your repayment obligations even if the interest rate increases.
Ultimately, the best loan structure for you will depend on your financial situation. To discuss your situation in more detail, get in touch with us today.