Loans come in all shapes and sizes, and to find the right one for you requires research and thoughtfulness.
For example: personal or business loans can come with fixed rates or variable rates, and the difference between the two is pretty significant, with discrete differences. A fixed rate allows you, as the borrower, to predict and guarantee your future payments and interest accumulation accurately throughout the term of the note.
A fixed-rate loan is one interest rate secured to your loan for its entire term. Not fluctuation, no sudden changes, just one, steady rate.
A variable-rate loan is tied to the market. So as the market shifts, so does your interest rate—and your payment.
So how do you choose the right one for you? Let’s look at some things you may want to consider:
- The term of the loan – If you opt for a longer loan terms, there is a higher chance your variable rate will adjust. If you’re considering a longer long period, you may want to go the fixed route instead.
- Fluctuating market changes – If you are considering a variable rate, do your homework and review the market to see if the prime lending rate is rising, how much and how often.
Variable rate loans:
So the variable rate works like this: Your loan interest changes as the loan index your rate is based on changes. Those loans can be based on different things, such as the rate of a prime lending rate or a one-year T-bill. That rate is set by most of the top 25 U.S. banks and will directly influence how much interest you pay and how much your payment is each month. Keep in mind that some lending institutions may structure the variable terms with a cap and/or floor rate to protect the borrow. It’s important to do your homework when looking to borrow money if this is a feature you’re considering.
- Your rate can change at any point, sometimes drastically changing what you pay per month and in interest. That instability can be disorienting and be difficult to budget around.
- If the market is fluctuating the rates frequently, your costs may accelerate much quicker, which doesn’t provide much stability to your loan payments.
- Depending on the market, you might begin at a low rate—or a lower rate than a fixed-rate loan. Which will save you money in the long run (if the rate stays low).
- If, when you take the loan out, the rate is low and you know you’re going to be paying back the loan in a short time, then this might be a good option.
- If your credit isn’t great, a variable-rate loan might be more available than a fixed-rate loan. You may be granted a bigger loan at a variable rate than a fixed rate.
All of that complicated index and market stuff? Not relevant here. Your interest is uninfluenced by any outsize forces (well, at least not directly)—it’s set when you take the loan and stays consistent throughout the duration of your term. Your first payment and last payment are the same.
- If the market interest rate drops well below your fixed rate, it’s possible you could be paying a higher rate than you would have with the variable loan.
- It can be harder to get a fixed-rate loan if your credit is less than stellar. Which can be frustrating.
- Fixed rates may be higher than an adjustable rate.
- You know going in what your principal will be and your rate.
- You’ll know and be able to rely on what your monthly payment is each month, which may give you more structure, safety and security during the length of your loan.
So as with all things in life, making a decision between fixed- and variable-rate loans is mostly about how much risk you’re willing to take. Go risky and you could pay a lot less (or a lot more). Or choose something more stable and budget with confidence.
But when should I take a loan?
While your fixed-rate loan is your safest and securest bet for a loan, you also want to make sure you’re taking a loan for the right reasons. A fixed-rate loan can feel like (and be) a relieving solution to a pressing problem, but you want to ensure you’re equipped to make your monthly payments.
A fixed-rate loan is also a boon to entrepreneurs or practice-owners who want to make meaningful and, in the long term, lucrative expansions to their business. But moving too quickly can undermine that investment. So it’s important to be careful when making this decision.
Here are some questions to ask yourself before you make your decision:
- Is it necessary to make this purchase now?
- How much can I afford to pay each month? And for how long?
- Can you easily make the payments?
- Is this interest rate lower than what you’re paying on your other debt?