Variable rate vs. Fixed rate loans
Anytime you look for a loan, you need to decide whether you are going to get a variable rate or a fixed rate. There are pros and cons to each type of loan, and it’s important to carefully consider your situation, and decide what would work best for your financial situation.
With a variable rate loan, the interest rate changes regularly. Often, the lender pegs the base rate to a benchmark, or prime rate, adding a certain percentage, based on your credit and the type of loan. So, if the benchmark rate is, your variable rate might be +15, or it might be -2. The lender will let you know how often the rate is changed, whether it’s reviewed monthly, quarterly, semiannually, or annually.
As the prime rate changes, your interest rate changes with it. If the prime rate goes higher, your variable home loan, or your credit card, interest rate changes to reflect the changes in the markets. On the other hand, if the prime rate drops, your loan becomes less expensive.
The main advantage of a variable rate loan is that you usually start with a lower interest rate, especially with home loans, than you would see with a fixed-rate loan. This can be helpful if you are looking to start out with a lower payment overall.
However, the problem with the variable rate loan is that it can change. You can’t expect to have the same interest rate throughout the term, and that means your regular payment can change on a home loan. If goes up, you might have trouble affording the cost later down the road, particularly if rates shoot higher. With a home loan, many of those who choose variable rates try to refinance before the interest becomes too expensive.
The biggest advantage to fixed-rate loans is that you protect against rising interest rates. You lock in a rate now, and it doesn’t ever go up — no matter what happens later with interest rates. Over time, especially if interest rates head higher, a fixed-rate loan can save you money, since you don’t have to pay the rising cost of interest.
Having a fixed-rate loan is advantageous because it means that you can plan for a specific payment over time. It makes it a little easier to plan your budget out since you know that you will always make the same payment.
What should you choose?
With a credit card, you might not have the option; few credit cards these days offer fixed rates. However, you might be able to choose between a variable and a fixed rate for your home loan.
Consider your situation. For some starting out with a variable rate makes sense. These are home buyers who have a fairly solid financial situation, and who are willing to make sure that they build up equity so that they can refinance to a fixed rate if rates start to rise.
For many, though, a fixed rate is preferable at first. It gets rid of the risk that you might not be able to refinance later, and it increases your chances of a lower overall cost over time.
In the end, though, you have to decide what will work best for you, and then go from there.