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Variable versus fixed interest rates on a loan

 
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Whether it’s for a personal loan or a home loan, when it comes to the interest rate you’re charged, you have two main options: fixed or variable.

Fixed versus variable: What’s the difference in a nutshell?

A fixed interest rate

If your loan has a fixed interest rate, the rate of interest you’re charged won’t change for a set period. This means your repayment amount won’t change and can give you more certainty about the total amount you need to pay back.

Fixed interest rate personal loan: The interest rate usually stays the same for the entire duration of the loan. As the loan balance reduces, the amount of interest charged per month will reduce too.

Fixed interest rate home loan: There’s usually a set fixed period at the start of the loan. During this time, your interest rate stays the same. When the fixed period is finished, the loan will often revert to a variable rate, unless you arrange with your lender to fix it again.

A variable interest rate

If your loan comes with a variable rate, the interest rate you’re charged (and therefore the total cost of your loan) can go up or down. The interest rate on a loan can change for a number of reasons, including decisions by the Reserve Bank of Australia and overall market conditions.

Fixed and variable rates both have potential benefits. Knowing what these are will help you decide which option is best for you.

The benefits of a fixed rate

  • Budgeting

    With a fixed rate loan, you should know at the outset how much you’ll need to pay back. This means you can work out what you’ll be paying weekly, fortnightly or monthly and when your loan will be paid out. Knowing that your regular payments won’t change can be helpful for budgeting. It means you’ll know exactly how much you need to set aside for your loan repayments.

  • Peace of mind

    Interest rates can rise and fall due to a number of factors as mentioned above, all of which are out of your control. Knowing that the interest rate you are charged won’t go up can offer borrowers great peace of mind (you won’t have to take a deep breath every time interest rates are mentioned on the news). On the flip side, you won’t benefit from rate decreases if they happen.

Other things to consider with a fixed loan

With a fixed loan, if you decide to change your financial institution, or pay off your loan early, some lenders may charge an early payout fee. There are also often restrictions on making extra repayments on your loan while it’s fixed. Make sure to look carefully at the loan terms and conditions so you know what restrictions and fees might apply.

The benefits of a variable rate

  • Opportunity to save

    With a variable rate loan, if interest rates go down, you can save on the amount of interest you have to pay back. Although it’s always worth bearing in mind that if interest rates rise, your minimum loan repayments are likely to go up.

  • Greater flexibility

    Variable loans often allow the borrower to have greater control over how they make their repayments. For example, with some variable loans you can make unlimited extra repayments if you have some extra cash, something that can be restricted with fixed rate loans. You may also have the option of paying out your loan early without any penalty.

  • Potentially a lower interest rate at the start

    Variable loans often come with a lower initial interest rate than fixed loans. This is because with a fixed loan you’re paying to ‘lock in’ that rate for a set period.

Are there any other options?

Some lenders allow you to split your loan (typically your home loan) between fixed and variable, to enjoy the benefits of both worlds. These options offer a combination of the certainty of a fixed rate as well as the flexibility of a variable rate. Extra fees, charges and restrictions on these types of loans may apply and vary amongst lenders. Make sure you’re informed about any costs involved upfront before committing to this, or indeed any, type of loan arrangement.

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Important information: Please note that this is only intended as a general guide in relation to issues you may want to consider when taking out a loan. It is not intended to be an exhaustive list of all relevant issues and you should take into account your own particular circumstances, and obtain independent expert advice where needed, before proceeding.

Oct 26, 2017 | Found in: news, homeloan, personalloan,
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