Loans are a valuable help and a very important financial tool to use. Whether to go to school, buy a car or even buy a home, loans are often needed 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 the loans can save their lives. Fortunately, loans are quite affordable today compared to ten years ago, making approval easier than ever before. In addition, with many lenders offering loans, you do not lack places to do research and choose. So, even though getting a loan today is probably easier and better than ever before, you have hard choices to make. Of course, you have to choose where to get your loan, etc., but one of the most important choices in borrowing is to choose between a fixed rate loan and a variable rate loan.
I hope this article will help you make this decision because we will look at what these loans are, the pros and cons of each, and more.
What are fixed and variable loans?
Before diving into pros and cons or starting to look at what is best for your situation, we need to explain what makes a loan relative to what makes it variable.
A term loan is a loan with an interest rate that stays the same for the duration of your term, regardless of market fluctuations. This means that your monthly payments for the duration of your loan will stay the same.
A variable loan, on the other hand, is a loan in which the interest rate will fluctuate throughout the life of your loan. The evolution of the rate throughout 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 a lot 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.
- Everything that happens on the market will not dictate the amount you pay.
- Generally easier for beginners because you do not have to watch them as much.
- If interest rates go down, you will not benefit unless you are able to refinance.
- The fixed loan rate is often higher than that of variable loans.
- If rates go down one day, you will miss some savings.
- Often less expensive over time and currently have lower rates.
- They are more flexible and can contain additional features and benefits.
- There can be a lot of uncertainty because the rate and the payments will fluctuate.
- If interest rates rise, your payments will also increase.
- May be more complicated to understand and require monitoring.
As you can see, both types of loans are good in some respects and bad in others.
What is the best?
Of course, the best type of loan will depend on many factors. The prime and most obvious factor is the current market and the current interest rate. If variable (market) interest rates and fixed interest rates offered by providers are close, it is often wise to choose a fixed mortgage. Indeed, you will get a similar rate without the risks associated with a variable rate loan. If the gap is large, it makes sense to use a variable loan, even if the rate increases slightly, you still get a good deal.
In addition, the market trend must also be taken into account. 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 increase, opt for a fixed rate.
What is most important for your current lifestyle?
Another factor to consider is the degree of valuation of stability and predictability in interest rates. If you want payments to always be the same, you may be willing to pay a premium to get a fixed rate loan to ensure your payments are not everywhere. If you are a bit more risky and agree with fluctuating payments, a variable rate loan will work for you. Variable lending seems to be more beneficial for the risk taker because there is a real battle between risk and reward, while a fixed rate loan will not change as long as you have it. Another element to consider is your overall financial situation and the amount you have to spend each month on these payments. If you’re tired of “overcoming a few storms,” you’re probably more willing to take the risks of a variable rate loan. If you struggle a bit and you can not support an increase in your payments, then go ahead and opt for a fixed rate loan because your payments will be constant and there will be no surprises.
Is predictability important?
In general, fixed rate loans are more suitable for those who prefer the predictability of regular monthly payments, can claim low interest rates and are convinced that interest rates will rise in the coming years.
Floating rate loans are beneficial for those who are more comfortable taking risks, do not worry about inconsistent payments and think interest rates will go down from what they are now.
Whatever your choice, make sure you have thought a lot. Remember that having a loan is extremely useful and a good thing, but being stuck and not being able to pay it back is not good. So be careful and make sure that the loan payments for which you are responsible are within your means. Before deciding to start a loan and choosing variable or fixed, it is wise to do some research and step back to make sure you make the right choice based on your current financial situation and needs.