If you take out a loan from a bank or other financial institution, they will charge you interest on the loan — that’s how they make money. The interest rate is one of the most important factors to weigh when considering a loan, along with the amount of the loan and how long you have to pay it off.
The question is: Do you want a fixed interest rate or a variable interest rate?
Why Do These Rates Matter?
It’s critical to know which rate is best for you if you want to take out a loan. Loans that may come with your choice of interest rate include:
- Mortgages: The question of interest rate is most pertinent to mortgages, as a mortgage is typically the biggest and longest loan most people get.
- Refinancing a mortgage: If you want to refinance your mortgage, you’ll need to choose your preferred rate for the new loan terms.
- Personal loan: If you want a loan for a reason other than a mortgage, a bank may offer you your choice of rate.
What’s a Fixed Interest Rate?
When an interest rate is fixed, it doesn’t change. That will be the rate for the entire length of the loan, or if a loan is divided into terms, for the length of the term. This means if the market interest rate goes up or down, it will have no effect on your loan’s rate. Your payments will be the same for the duration of the term.
A fixed loan remains at the prevailing market interest rate at the time you take out the loan, plus or minus a spread that is unique to the borrower.
What’s a Variable Interest Rate?
Variable interest rates vary over time. The rate the bank charges on the outstanding balance will fluctuate according to an underlying benchmark or index, such as the federal funds rate. That means as the market rate changes, so too will your payments. If the market rate decreases, your monthly payment will be lower. If the market rate increases, you’ll have to pay more.
Which is better?
It depends. It depends on what the market is likely to do over the course of your loan. And it depends on your personal tolerance of risk and uncertainty.
Choose a fixed interest rate if…
You think the market rate will increase during the term of your loan. It’s important to do your research and see what financial analysts predict the market will do. However, you must remember Wall Street is paved with incorrect predictions. Forecasting the market always involves a little guesswork, especially when trying to predict two decades into the future, which might be the length of your mortgage.
If you want to know exactly what you’ll pay each month so you can budget accordingly, pick a fixed rate loan.
Choose a variable interest rate if…
You think the market rate will decrease. Just know it might not, so you should prepare for rate increases. Some financial institutions also offer perks with variable interest rates, such as low introductory rates.
Want to learn more about interest rates? Contact a Vectra Bank professional today.
