Fixed-Rate vs. Variable-Rate Loans

In today’s unpredictable economy, knowing the ins and outs of fixed-rate vs. variable rate loans is more important than ever. Interest rates can rise or fall, and the loan you choose could mean the difference between predictable payments, unexpected surprises, and maybe even extra savings.

Learn more about the differences between fixed-rate and variable-rate loans, their pros and cons, and some practical tips to help you decide which one is right for you.

The basics: Fixed-rate vs. variable-rate loans

Fixed-rate loans are predictable and perfect for long-term planning. Fixed-rate loans lock in your interest rate for the entire loan term. That means no matter what happens in the market, your monthly payments always stay the same.

They’re a great option for borrowers who value stability and want to simplify budgeting. Whether you’re taking out a 30-year mortgage or a shorter-term personal loan, you’ll know exactly what you owe each month.

Variable-rate loans, also called adjustable-rate loans, come with interest rates that change over time. These rates are tied to a financial index and can increase or decrease based on market trends.

Variable-rate loans typically start with a lower interest rate than fixed-rate options, offering initial savings. This can make them appealing for short-term borrowers or those expecting rates to stay low, but there’s a tradeoff: your payments could rise in the future if rates increase.

Why choose a fixed-rate loan over a variable-rate loan?

Fixed-rate loans are all about stability and predictability, offering peace of mind and simpler financial planning. Fixed-rate loans are good for people who are looking for:

• Budgeting made easy: Your monthly payment stays the same throughout the loan term, keeping your budget simple and surprise-free.
• Protection from rate hikes: Once you lock in your interest rate it won’t change, no matter what happens in the economy.
• Simplicity: There’s no need to monitor market trends or worry about monthly payment increases. A “set it and forget it” approach to repayment works just fine.
• Long-term funding solutions: For significant expenses like mortgages, student loans, and home renovations, fixed-rate loans provide a sense of security.

Potential drawbacks of fixed-rate loans

Fixed-rate loans come with many benefits, but they aren’t without their tradeoffs, including:

• Higher initial interest rates: The cost of long-term stability and protection from market changes is factored into fixed-rates, so they typically start higher than variable rates.
• Missed opportunities for lower rates: If market rates fall, your fixed-rate stays the same—which could mean paying more interest over the loan term than a variable-rate option.

While these drawbacks are worth keeping in mind, fixed-rate loans are still a solid choice for those seeking stability and predictability. Let’s explore the advantages of variable-rate loans next.

Why choose a variable-rate loan over a fixed-rate loan?

Variable-rate loans can be appealing if you’re looking for flexibility and potential savings upfront. These loans are good for folks who value:

• Lower initial costs: These loans usually start with a lower interest rate, which means smaller monthly payments at the beginning.
• Potential to save money: If rates drop, your monthly payments decrease too—putting extra cash in your pocket. Even if rates rise later, the early savings could keep you ahead.
• Great for short-term goals: If you plan to pay off your loan quickly or expect rates to stay low, a variable-rate loan could be the right choice.
• More equity, less time: For mortgages, lower initial rates mean more payments go toward the principal, helping you build equity faster.

Potential drawbacks of variable-rate loans

Of course, variable-rate loans aren’t for everyone. Before deciding if one is right for you, consider these factors:

• Unpredictable payments: If rates go up, your payments go up. Long-term planning can be difficult because you never know when your budget could take a hit.
• Complicated loan terms: With rate caps, adjustment periods, margin rates and more, variable-rate loan terms can be more intimidating than fixed-rate options.
• Savings aren’t guaranteed: Although variable rates typically start lower than fixed, if rates rise significantly during your loan term, you could end up paying more compared to locking in a fixed-rate.

Making the choice: Fixed-rate vs. variable-rate loans

Choosing between a fixed-rate and a variable-rate loan is a big decision that affects everything from monthly payments to long-term savings, so it’s worth taking time to weigh your options. Let’s break down the key factors to consider.

Your financial situation and goals

• If your income is steady and predictable, you may feel comfortable with the potential changes of a variable-rate loan.
• Do you have enough savings to cover potential rate increases? If not, a fixed-rate loan could offer peace of mind.
• Big life changes like starting or family or switching careers could impact your ability to handle fluctuating payments.

Risk tolerance

Think about how comfortable you are with uncertainty.

• If you value predictability and knowing what to expect, a fixed-rate loan is likely the better option.
• If you’re open to taking on some financial risk for a chance to save on interest, a variable-rate loan could be right for you.

Loan term

For short-term loans from 1-5 years, variable-rate loans may work well since there’s less time for rates to rise significantly. For longer-term loans of 15+ years (like a mortgage), the stability and predictability fixed-rates provide could be more appealing.

If your loan is somewhere in the middle, either option could work—it all depends on your risk tolerance, financial situation, and market trends.

Loan amount

For larger loans, even small rate changes can make a big difference in monthly payments, so fixed-rates may feel safer. For smaller loans, variable rates may be less risky.

Loan purpose

The reason that you’re borrowing can guide your decision.

• Home mortgages: Many prefer the stability of fixed-rates for their primary home.
• Investment properties: Variable rates could be appealing if you plan to sell or refinance soon.
• Personal loans: Your choice should depend on the amount borrowed, your financial stability, and economic trends.

Loan features and flexibility

If you’re leaning toward a variable-rate loan, look closely at the details.

• Are there caps on how high the variable rate can go?
• Can you switch from a variable rate to a fixed-rate if needed?
• Are there options for extra payments or flexible terms?

Current economic climate

If rates are low but expected to rise, locking in a fixed-rate could make sense. If rates are high but likely to fall, a variable rate could save you money over time.

Refinancing opportunities

If you expect your credit score or finances to improve, you might start with a variable rate and refinance to a fixed-rate later. Just remember, refinancing has costs and isn’t guaranteed.

By taking the time to consider these factors, you’ll be better equipped to choose between a fixed-rate vs. variable-rate loan. There’s no universal answer—the right decision depends on your unique circumstances.

Key tips for navigating the loan selection process

• Do your homework: Research loan terms, market trends, and trusted financial resources to understand your options. Consult a financial advisor or accountant if you need a hand.
• Shop around and compare: Compare offers from multiple lenders, considering rates, fees, and terms. Use online calculators to explore price estimates and payment schedules.
• Consider your entire financial picture: Ensure the loan fits your goals, debts, and potential future changes. Calculate if your budget can handle higher payments in a variable-rate scenario.
• Read the fine print and trust your instincts: Be sure you understand the loan’s terms, fees, and potential rate adjustments before signing. Most importantly, choose a loan that fits your risk tolerance and gives peace of mind.

Conclusion

Choosing between a fixed-rate and variable-rate loan comes down to what works best for your situation. It’s not just about the rate today—it’s about finding the option that gives you confidence, fits your financial goals, and helps you rest easy knowing you’ve made the right choice.

This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.