An interest rate is how much you’re paying to borrow money from lender. Every loan has an interest rate attached to it which is used to calculate the amount of extra money you need to pay back over a period of time.
Whether you’re looking for purchasing a home and taking out a mortgage comparing options for a debt consolidation loan or you’re just evaluating your current debts something very important to consider and keep in mind is whether you’ve got a fixed or a variable interest rate.
What factors determines variable interest rate?
If an interest rate is fixed it will never change over the time period of the entire loan but in variable interest rates the interest can change over time. The variable interest rate interest rate might fluctuate over time based on prevailing interest rates may go up or down. The mechanism that determines whether a variable interest rate goes up or down is usually tied to an international standard The London Interbank Offered Rate(LIBOR) which sets the benchmarks which usually changes based on supply and demand in international markets.
In general variable interest rates don’t change by anything in your control or your lenders control if you’re wondering why anyone would want a loan with an interest rate that could increase at any moment due to circumstances beyond their control. You might hear a term called a variable loan cap and that just means that’s the maximum limit on the interest rate that you can be charged regardless of how much the index interest rate changes if the variable loan cap is 10 for example then once your variable interest rate hits 10 even if the index interest rate increases again your variable interest rate won’t go above that 10.
Why and when to choose variable interest rate?
Fixed interest rates are quite straightforward and simple but when it comes to variable interest most of the times people believe that interest rates could decrease and one of the main reasons is that banks typically make variable interest rates lower than fixed interest rates. Variable interest rate could look very attractive but take a second to think about it this way banks who are loaning you money are interested in you paying them back with as much interest as possible so that they can maximize their profits.
They must be employing experts whose sole job is to determine with some degree of certainty which direction those international markets will go over the course of your loan and surely they’re betting that if you go with the variable interest rate that you’ll eventually pay them the same or more over your long term than if you’ve selected a fixed interest rate otherwise it wouldn’t make much sense for them to offer you that lower rate the fixed interest rate may be higher at the beginning but you can be fairly certain it won’t be higher for the entire term of your loan.
What is best for you?
Ultimately whether a fixed or variable rate loan is best for you is going to depend on some factors like your personal situation and preferences your risk tolerance financial goals and length of the loan. If your interest rate increases above your comfort zone you may qualify to refinance it again into a fixed rate.
If your budget is pushed to the limit or if you’re working hard to pay off debt you do not want your monthly payments to suddenly increase without warning there are a few cases in which a lower variable interest rate could be used to your advantage like if you’ll be paying back a long-term loan in a very short amount of time but in the vast majority of cases the fixed interest rate is the way to go if you would like a lower fixed rate you can usually get one by reducing the term of your loan but this will usually come with increased monthly payments if you can afford it though this is a great option