For most people day to day, a fixed interest rate is likely to be the prudent and safer way to go. The downside is that it may feel boring, but knowing what you can spend each month takes all the anxiety away from spending money when budgeting is already so close to the edge. I realise I am skipping ahead in the explanation of the two types of interest rates, but the point I am trying to make is that we are looking at things in a beautifully jumbled order.
When banks provide you with a “lower” variable rate, they are not doing it because they have any special feelings toward you or any desire to give you a discount. Banks have done their own analysis and use employees to predict how global benchmark interest rates will behave over time. If your bank is providing you with a low variable rate right now, it is a good guess that over the life of the loan you will end up with either the same total amount paid on the loan, or a greater amount than if you were to go with the fixed rate.
So what exactly does “fixed” and “variable” mean when it comes to loans?
Going back for a moment:
When you take out a loan, you will pay an interest rate, or the price you pay to borrow money. With a “fixed” interest rate, this number remains the same from the minute you take out the loan until you make your last payment. No surprises.
Variable rates can shift or alter (increase/decrease) over time. The lender (and therefore you) have no control over that. The lender cannot predict how high the rate will go (or low), and depend upon a larger financial indicator or standard (usually an index such as LIBOR) that will fluctuate with the international supply/demand for credit.
So if you take out a mortgage at the lower or starting(variable) rate, you base your mortgage payments on the idea that the banks/emerging lenders are going to look towards lending to one another.
Therefore, your mortgage payment may very well be depending on how the major world banks feel towards lending to each other (possibly making mortgage payments for you). Great.
The reason so many people choose variable-rate mortgages is because of the lower interest (price) at first. If you’re at your limit (financially), that discount (initially) may be your best (possible) option. They can also be incredibly stressful the moment your variable rate increases or changes.
If you think “my mortgage payment will suddenly increase” sounds bad, you know you should go for a fixed-rate mortgage.
You may ask “but what if the rates changes to the LOWER side?”, which means the same as: “the variable or BLENDING rates can change”.
Yes, interest rates have the potential to decrease, but if you are getting a long-term loan (but only plan to pay it off in a short period of time), it may be advantageous for you to take a variable rate loan. An analogy to this situation is staying at a hotel for a month but only staying for two days and leaving before the fees get who knows how high.
For most borrowers, particularly those dealing with multiple obligations or budgets, placing their entire financial stability on the notion that rates will decline or that the economy will improve is typically not the best way to approach their financial future.
Why This Matters
If you’re searching for a mortgage, want to explore debt consolidation loans, or want to learn about what you owe and how to pay your bills, one of those small details that really does add up to big differences is whether your interest rate is fixed or floating. Changes in payments whenever you least expect them can affect your credit score, budget, and peace of mind.
Yes, it makes a huge difference to have a choice.
If you are interested in finding a lower fixed interest rate, generally, you will be able to find one if you choose a shorter loan term, even though this means that your monthly payment will be higher, but your total amount of interest paid over the life of the loan will usually be much lower. So, if you can manage the increase in your monthly payment, that would be a huge benefit for you.
Variable interest rates generally look more attractive than fixed interest rates at first; however, in reality, fixed interest rates provide more stability and predictability for most people and, because of that, are the better long-term financial choice for most people. If you choose a variable interest rate and you happen to have a payment increase on a random day, you’ll wish you had selected the fixed option.
When you look at these two types of interest rate options, the “smart” choice for most people is pretty clear. However, the decision is still yours to make.
