A payday loan is a fixed interest rate loan. This means that the interest rate charged always remains the same. A fixed rate loan means that you always know how much you’ll be paying back over time. In this article, we will examine the differences between fixed and variable rate loans.
What is the Difference Between a Fixed Interest Rate Loan and a Variable Interest Rate Loan?
A loan with a fixed interest rate is guaranteed to have the same interest throughout the loan period. Whatever rate of interest that you agree to pay is exactly what you will pay for the entire borrowing period. A fixed interest rate loan is particularly suited to those who like to plan their finances exactly and know exactly what they will be paying. A fixed interest rate loan means that there will be no fluctuation in the amount you pay, no matter what happens to the market.
A loan with a variable interest rate, on the other hand, means that the amount you pay can changed based on the circumstances of the national market. So borrowers who believe that interest rates will decline tend to choose variable interest rate loans. In general, variable rate loans will have lower interest rates than their fixed counterparts. This is in part because they come with a certain amount of risk. Rising interest rates could greatly increase the cost of borrowing. Consumers who choose variable rate loans should be aware of the potential for elevated loan costs.
What is Better, a Fixed Rate Loan or a Variable Rate Loan?
When it comes to interest rates, it is a little more complex than simply better or worse. There are advantages and disadvantages to both fixed and variable rate interest rates.
The big advantage of having a fixed rate loan is that you will always know exactly what you are paying, with no surprises. This can make financial planning easier and increase peace of mind. For anyone who values predictability in their finances, or cannot afford the risk of a variable rate loan, a fixed rate loan is the right choice.
The main advantage of a variable interest rate loan is that there is the possibility of saving money. With long-term loans, like a mortgage, it is possible that the interest rates will drop over the term of the loan. If interest rates do decrease during the term of the loan, you will save money. However, there is also the distinct possibility that the interest rates could rise, meaning that borrowing is more expensive than you originally anticipated. For those who are willing to take the risk, variable rate interest loans are a potentially good choice.
Furthermore, if you know that you will be able to pay off your loan quickly, a variable rate interest loan could be a better option. This is because the starting rates for variable interest rate loans are generally lower than their fixed rate counterparts. This lower starting rate is designed to balance out the extra risk for borrowers.
Which Option Do Different Loan Types Use?
| Type of Loan | Variable or Fixed? |
| Mortgages |
Usually, with a mortgage, you can choose a mortgage with a fixed rate of interest or variable rate. There are widely available options for both. Which one is right for you will depend on what you can afford and the level of risk you’re willing to take.
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| Payday Loans |
Payday loans are offered as a fixed rate interest loan. This means you’ll always know exactly how much interest you need to pay and what it will cost you, no matter what happens in the market.
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| Student loans |
Whether or not your student loan is a fixed or variable rate will depend on your lender. Generally speaking, a good choice for a student loan is a fixed interest rate student loan, because you have the certainty of knowing exactly how much you owe and how long it will take to pay you off.
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| Personal loans |
For a personal loan, borrowers tend to opt for a fixed rate loan because of the security and certainty that it can offer them. Just like with a payday loan, the predictability of a fixed interest rate loan is invaluable to a borrower.
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Example of a Fixed Rate Loan
If you took out a fixed interest rate personal loan of $300 at 11% interest over 6 months, you will pay a total of $309.70, with 6 monthly payments of $51.62.
Example of a Variable Rate Loan
If you took out a variable interest rate mortgage loan of $50,000 over 25 years, with an initial interest rate of 4% fixed for 60 months with subsequent 0.25% interest rate adjustment every 12 months, you will pay a total of $104,970, with initial monthly payments of $238.71.