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Fixed-rate vs. variable-rate loans, what is the difference and which one should you choose?
When taking out a loan, particularly when it comes to mortgages, you will be tasked with choosing between a fixed rate and a variable rate. But, do you know the difference and how each rate type will affect your debt? Keep reading to learn about fixed and variable rates.
Fixed-rate and variable-rate loans can dramatically change the cost of your loan and repayment amount. Depending on your financial situation, one option will be better suited to you than the other.
A fixed loan is a loan in which the interest rate will remain the exact same throughout the duration of your term, no matter how much the market fluctuates. This means, your monthly payments throughout your loan term will remain the same.
A variable loan, on the other hand, is a loan in which the interest rate will fluctuate throughout the lifetime of your loan. Variable-rate loans are advertised as prime plus/minus the interest rate (ex: prime+1.5%). How much the rate changes throughout the loan will depend on the current conditions of the market.
As a credit user in Canada, there are several variable rate loans you can find, such as:
Mortgages can have fixed or variable rates. In the case of a variable-rate mortgage, your interest rate will fluctuate according to Canada’s prime rate, which will change throughout your term based on market conditions. So, while you have regular payments to keep up with, your variable rate affects the amount of principal you pay every month.
When variable mortgage rates drop, a larger part of your regular payment will go toward paying your principal. When they climb, a larger portion will be applied to your interest. It’s also important to know that variable-rate mortgages tend to have more flexible terms than fixed-rate mortgages, but this depends on what type of loan and lender you get.
Similar to a credit card, a personal line of credit allows you to borrow money from a predetermined limit. You can use the money for any expense and spend as much as you need, up to that limit.
Generally, personal lines of credit feature variable interest rates. Additionally, you’re only required to pay interest on the amount you borrowed until you repay it completely. Payment for the principal amount is only required after the draw period is over, however, you’re free to pay back the amount you owe before that.
In Canada, you may come across many kinds of fixed-rate loans too, including:
Personal loans can also feature fixed and variable interest rates. However, unlike a variable rate, a fixed rate doesn’t change during your entire payment term. Although fixed rates can sometimes become higher than variable rates, your payments will stay the same, no matter what the state of Canada’s economic market is at the time.
Fixed-rate mortgage payments are more predictable than they are with variable rates, which makes them a popular choice in Canada. As long as your rate fits your monthly budget, all you have to do is set up an affordable payment plan. Depending on the lender you choose, you can get a fixed-rate closed mortgage, a fixed-rate open mortgage or a fixed-rate convertible mortgage.
Keep in mind that fixed-rate mortgages are often linked closely to the bond market. That means fixed mortgage rates tend to rise when Canada’s bond rates go up.
Fixed interest rates are also common with car loans. You can typically apply for a fixed rate through your bank, credit union, online lender or vehicle dealership, but no matter where you go, comparing multiple quotes before applying is definitely the best strategy.
Like with personal loans, fixed-rate car loans can end up being pricier than variable-rate loans, especially when there’s a drip in Canada’s economic market. While they can help make a new car more affordable, you may save less money with a fixed-rate auto loan.
Although fixed-rate car loans are more popular in Canada, lots of auto lenders now offer variable-rate payment plans for new and used vehicles too. Just remember that variable rates can increase with the market at any point. On top of that, some lenders don’t have a rate cap, which means there’s no limit on how high your variable interest rate can get.
Historically speaking, variable rates have led to less interest being paid amongst our residents. Then again, just because past rates have been low, doesn’t mean they’ll stay that way forever. Our country’s economy is always changing and the longer your loan term is, the more interest you’ll pay during. Plus, the market will have more time to shift.
Here are some key factors to consider when choosing between fixed-rate vs. variable-rate loans:
Whichever you decide to go with, you should ensure you put a lot of thought into it. Just remember, a loan is a helpful tool, but it can also lead to unmanageable debt if not used responsibly. Ensure your loan payments are well within your means. Before you apply for any loan, it is a good idea to do some research and take a step back to ensure you are making a good choice based on your current financial situation and needs.
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