Fixed vs. Variable Rate Loans

What is the definition of a Fixed Rate Loan?

Fixed rate loans are loans that have an interest rate that does not change over the life of a loan, which means you pay the same amount each month. It also means you know with certainty the total interest that you’ll pay over the life of the loan. Fixed rate is a general term that can apply to different types of loans with a variety of uses, including student loans, mortgages, auto loans, and unsecured personal loans.

What is the definition of a Variable Rate Loan?

Variable rate loans are loans that have an interest rate that will fluctuate over time in line with prevailing interest rates. They generally have lower starting interest rates than fixed rate loans, but the interest rate and payment amounts can change over time. Sometimes they are also known as floating rate loans.

How does a variable loan work?

Variable rates are usually pegged to changes to a well-known index, such as the 1-month LIBOR. LIBOR (the London Interbank Offered Rate) is the interest rate that banks charge one another to borrow money; the 1-month means that the variable rate can change monthly. A rate change one month also changes the monthly payment due for that month, as well as the total expected interest owed over the life of the loan.

What is a variable loan cap?

A cap on a variable rate loan is a maximum limit on the interest rate that you can be charged, regardless of how much the index interest rate changes.

How to Choose?

What’s the best option for you? There’s no universal right or wrong answer. The decisions on loan amount, term, and fixed or variable rate all depend upon your personal situation and flexibility.

If you like the consistency of knowing exactly what your monthly payments will be over time, you might prefer a fixed rate loan. Also, if you plan to pay your loan back over a longer period of time, say 10, or 20 years, you might prefer to eliminate the risk of interest rate changes over time by selecting a fixed rate loan.

In contrast, you might prefer a variable rate if you want to take advantage of the maximum possible savings but have the financial flexibility to make higher monthly payments and total interest should interest rates rise. You might also prefer variable rate loans because you plan to pay off your loan in a short timeframe, such as 10 years or less.

Interest rates on variable rate loans depend on prevailing market interest rates, so the total interest owed will depend upon changes in the broader environment.

Ultimately the decision on the loan term, amount, and loan type depend on your personal situation. If you have further questions about selecting a loan type, don’t hesitate to contact us at 855.456.SoFi.