What is better, a loan with a fixed or variable interest rate?

Variable Interest Loan

Variable Interest Loan

A variable interest loan is a loan where the interest on the outstanding balance varies as the market interest rate changes. As a result, your payments may also vary (as long as your payments are mixed with principal and interest).

Fixed interest rate loans

Fixed interest rate loans

Fixed interest rate loans are loans where the interest rate on the loan remains fixed for the entire duration of that loan, regardless of the market interest rate. This will ensure that your payments are the same throughout the entire term. Whether a fixed-rate loan is better for you depends on the interest rate environment when the loan is taken out and the duration of the loan.

When a loan is entered for the entire term, it is set at the then prevailing market interest rate, plus or minus a spread that is unique to the borrower. In general, if the interest rate is relatively low, but is about to rise, it is better to secure your loan at that fixed rate. Depending on the terms of your agreement, your interest rate will remain fixed on the new loan, even if the interest rates rise to higher levels. On the other hand, if interest rates fall, it is better to have a variable-rate loan. As the interest rate falls, so does the interest on your loan.

This discussion is simplistic, but the explanation will not change to a more complicated situation. It is important to note that studies have shown that over time the borrower is warning. You will pay less interest in general with a variable-interest loan versus a fixed-interest loan. However, the borrower must take into account the repayment period of a loan. The longer the repayment term of a loan, the greater the impact of an interest rate change on your payments.

Therefore, adjustable interest rate mortgages (ARM) are beneficial for a borrower in a falling interest rate environment, but when interest rates rise, mortgage payments will rise sharply. Use a tool such as the Investopedia mortgage calculator to estimate how your total mortgage payments may differ depending on the type of mortgage you choose.

Read Choose your monthly mortgage payments and for more information about mortgages with adjustable interest rates and the impact of interest rate changes on interest rates. Mortgages: fixed interest rate versus variable rate .

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