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During most people’s lives, loans are a huge help and are a very important financial tool to use. Whether you are going to school, buying a car or even buying a home, loans are often necessary to achieve those goals. Fact is, most people don’t have thousands and thousands of dollars sitting around to pay for these things in cash, so loans can be a lifesaver. Thankfully, loans are quite affordable now compared to even a decade ago, which makes it easier than ever to get approved. Also, with many lenders offering loans, you have no shortage of places to research and choose from.
So while getting a loan today is arguably easier and better than ever before, you do have some tough choices to make. Of course, you need to choose where to get your loan from and things like that, but one of the biggest decision when it comes to getting a loan of any kind is choosing between a fixed rate loan and a variable rate loan.
This article will hopefully help you make that decision as we will look at what these loans are, the pros and cons of each, and more.
What Are Fixed and Variable Loans
Before we dive too deeply into the pro and cons or begin to look at which is best for your situation, we need to explain what makes a loan fixed versus what makes it variable.
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. How much the rate changes throughout the loan will depend on the current conditions of the market.
Check out this infographic to learn about the true cost of borrowing.
Pros and Cons of Fixed and Variable Loans
Now that you know what qualifies as a fixed loan and what qualifies as a variable loan, let’s take a look at the pros and cons of each and the major differences between the two main types of loans.
- Offers much more stability (monthly payments are always the same.)
- If you have a good credit score, you might be able to secure a very low fixed rate.
- Whatever is happening in the market won’t dictate how much you pay.
- Generally easier for beginners as you don’t have to monitor them as much.
- If interest rates go down, you will not benefit from them unless you are able to refinance.
- The rate on fixed loans is often higher than variable loans.
- If rates ever go down, you will miss out on some savings.
- Often less expensive over time and have lower rates currently.
- They are more flexible and may contain extra features and benefits.
- There can be a lot of uncertainty as the rate and payments will fluctuate.
- If interest rates rise, so will your payments.
- Can be more complicated to understand and requires some monitoring.
As you can see, both types of loans are good in some ways and bad in others.
Which is Best?
Of course, which type of loan is best will depend on a variety of different factors. The first and most obvious factor is the current market and current interest rate. If the variable (market) interest rates and the fixed interest rates offered by providers are close, it is often a good idea to go with a fixed mortgage. This is because you will be getting a similar rate, without the risks associated with a variable rate loan. If the gap is significant, then going with a variable loan makes sense as even if the rate rises a bit, you are still getting a good deal.
Also, the direction the market is trending in should be something to consider too. If you feel the interest rates will drop, go with a variable loan as your rate will drop with the market. However, if you feel they will go up, going with a fixed rate is the right thing to do.
What’s the difference between a variable and fixed rate mortgage? Find out here.
What is Most Valuable For Your Current Lifestyle?
Another factor to consider is how much you value stability and predictability when it comes to your interest rates. If you like payments always being the same, you may be willing to pay a premium to have a fixed rate loan to ensure your payments aren’t all over the place. If you are a bit more risky and okay with fluctuating payments, a variable rate loan will work for you. Variable loans seem to be better for the risk-taker as there is a definite battle between risk and reward taking place, while a fixed rate loan will experience no change as long as you have it.
Another to consider is your overall financial situation and how much money you have to allocate to these payments each month. If you have enough to “weather a few storms”, you are likely more willing to take the risks involved with a variable loan. If you are struggling a little bit and cannot deal with an increase in your payments, then go ahead and go with a fixed rate loan as your payments will be constant and there will be no surprises.
Is Predictability Important?
In general, fixed loans are better for those who prefer the predictability of consistent monthly payments, can qualify for low-interest rates and believe that interest rates will rise in the next few years.
Variable loans are good for the individuals who are more comfortable taking risks, don’t mind the inconsistent payments and feel that interest rates will drop from what they are currently.
Here’s how you can deal with the rising interest rates in Canada.
Whichever you decide to go with, you should ensure you put a lot of thought into it. Just remember, having a loan is extremely helpful and is a great thing, but being stuck and not being able to pay it back is not. So be careful and ensure the loan payments you are responsible for are well within your means. Before you decide to start any loan and pick variable vs. fixed, 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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