Is a Personal Loan Variable or Fixed Rate?
Personal loans differ from mortgages or car loans because you can use the cash for anything, be it credit card debt, home renovations, or unexpected expenses. The money isn’t tied to one specific purchase. Personal loans don’t require you to put up collateral, either. But one of the things you need to know before going into debt is: are personal loan interest rates fixed or variable?
The answer is, they can be both. Before signing on the dotted line, it’s important to determine whether variable or fixed rates are better suited to your situation. Let’s explore this further.
- Variable interest rate loans mean the interest you pay fluctuates depending on some index.
- Variable-rate loans can save you money when interest rates drop, but they can become costly when rates rise and your payments increase.
- A popular type of variable-rate loan is the 5/1 adjustable-rate mortgage (ARM), which has a fixed interest rate for the first five years and adjusts annually thereafter.
- Fixed-rate loans keep your rate and payment the same throughout the loan life. What you start with stays stable, regardless of the market’s changes.
What is a Fixed Loan?
A fixed-rate personal loan keeps the interest rate the same for the entire term. Fixed-rate personal loans let you know exactly what your monthly payments will be ahead of time, which makes it easier to budget and manage your money.
With a fixed-rate loan, the interest rate is determined at the start based on factors such as your credit score, prevailing market rates, and the lender’s policies. Once set, your rate stays the same no matter what happens to the industry.
When Should You Get a Fixed-Rate Personal Loan?
Fixed-rate personal loans can work well when the economic climate results in unstable interest rates. They make budgeting easier since your monthly payments stay the same. These loans allow you to consolidate high-interest debts, potentially saving money on interest. They give predictable repayment schedules and allow you to lock in low rates.
Financial experts see fixed rates helpful when you require stability. They provide consistency if your income stays relatively high and you have decent credit. Overall, fixed rates can reduce uncertainty when used wisely.
What is the Benefit of Having a Fixed Interest Rate Loan?
Fixed interest rates on loans can be helpful for budget planning. You always know your monthly payment, making it easier to determine what you can and can’t afford each month. It’s nice to have the peace of mind that your payment remains stable regardless of interest rate shifts.
Another bonus is that fixed rates protect you if interest rates go up. If you have an adjustable rate that changes over time, you could end up with a significantly higher total loan cost. However, with a fixed rate, the terms you agreed to at the start will remain consistent throughout the life of the loan.
- Fixed interest rates on loans can be helpful for budget planning. You always know your monthly payment, making it easier to determine what you can and can’t afford each month. It’s nice not having to stress about the payment going up or down depending on interest rates.
- Another bonus is that fixed rates protect you if interest rates go up. If you have an adjustable rate that can change over time, you might get stuck with a more significant total loan cost. But with a fixed rate, what you first signed up for is what you’ll keep paying for the whole loan life.
Drawbacks of Fixed Rate Personal Loans
Fixed rates on personal loans are excellent since you get more predictability. However, these loans also have disadvantages that you should consider.
- High-interest rates. You might get stuck with a higher rate than on a variable loan. Lenders look at the market and make their best guess at where rates are headed. To play it safe, they set fixed rates higher.
- Additional fees. Fixed-rate options may incur additional fees if the borrower wants to change terms or repay the loan early.
How to Get a Fixed-Rate Personal Loan?
Getting a fixed-rate personal loan involves several steps but doesn’t have to be complicated. Check out these stages to learn how to get one.
- Shop around. Look around at different banks and lenders to see who offers reasonable rates.
- Check the application requirements. Compare each lender’s specific interest rates, fees, eligibility criteria, and repayment rules. Ensure you also get all the paperwork you need ready—proof of income, job info, ID, etc.
- Apply online or in-store. Once you pick a good option, fill out the loan application form. It is better to find lenders with pre-qualification options that don’t affect your credit score.
- Check the loan offers. Look closely at the interest rate and fees the lenders charge and how long you’ll need to pay them back.
- Sign the loan agreement. Choose the option with the best terms and conditions and sign the loan contract.
- Receive your money. The lender will transfer the fixed-rate loan to your bank account within 1 to 5 business days, depending on its policy and your bank cut-off times.
What is a Variable Rate Personal Loan?
Variable-rate personal loans can be tricky. The interest rates go up and down based on the prime rate or LIBOR, which is used as a basis to set interest rates for all types of financial products. If a prime rate increases, your interest rate goes up, too. It means your monthly payments would increase. But if it goes down, your rate drops, and your payments decrease. Starting interest rates are usually lower than those of fixed-rate loans. Such products seem attractive if the rates are about to fall or you want lower initial payments.
Advantages of Variable Rate Personal Loans
Variable-rate personal loans can be a good option due to their flexibility and potential cost savings. Two main benefits are:
- Lower starting interest rates. When you first take out a loan, variable rates are often lower than fixed rates. Your initial payments would be less, saving you money upfront. Of course, that could change later. If you want lower costs initially, it’s something to think about.
- Possible savings if rates decline. With variable-rate loans, your interest rate floats up and down with the market. If benchmark rates drop, your loan rate would decrease, too. As a result, your monthly payments and overall loan costs would be lower over time. It lets borrowers take advantage of market fluctuations. With fixed rates, you’d be stuck paying the original higher amount no matter what.
Drawbacks of Variable Rate Loans
Variable-rate loans have significant downsides borrowers must consider before signing up. Here are two main disadvantages:
- Variable rates make budgeting challenging. With fixed rates, your payment stays the same the whole time, but variable rates move up and down with the market, so your payment is constantly changing. That uncertainty makes planning difficult, especially for those who already have limited flexibility in their budgets.
- Risk of rising rates. While variable rates start lower, over time, there’s always the possibility that rates will go up. Your payments and overall loan cost may suddenly become more expensive. If rates increase, it can stretch a tight budget to the breaking point. People might end up paying way more than they ever planned.
What To Consider Before Borrowing Variable Rate Loans?
Here are a few things to think about before choosing a variable-rate loan:
How Your Credit Score Affects Personal Loan Interest Rates
Your credit score directly affects the interest rate for a personal loan. Lenders look at your score to determine how likely you are to repay a loan. Borrowers with high scores make their payments on time and manage money well. Lenders see them as less risky and offer them lower interest rates.
What are the Interest Rate Caps?
Interest rate caps limit how much a variable interest rate can increase over time. There are usually two kinds of caps: periodic caps that limit how much rates can increase at certain intervals, like each year, and lifetime caps that limit the total rate increase over the entire loan term.
The periodic caps are straightforward. Say you have a 1% cap each year. This means that if your rate starts at 5%, the most it could go to the next year is 6%, and then 7% the year after. The lifetime caps work by setting a maximum rate increase from when you first get the loan to when you pay it off. A 5% lifetime cap means your rate can never get 5% higher than what you started with.
Interest rate caps assure borrowers that their payments won’t suddenly skyrocket if rates spike. Read all the terms of your loan agreement carefully to see what caps your loan has and what limits apply.
How to Choose Between Fixed and Variable Rates?
Choosing between fixed or variable rates requires analyzing your situation and market conditions. Here’s expert advice to make it easier for you to decide.
Consider your risk tolerance
How comfortable are you with uncertainty? Going fixed means you lock in your rate for the whole loan. Variable rates fluctuate, so your monthly payments could change over time. If predictability is vital, fixed rates let you plan without surprises. But if you can handle some fluctuation, variables may start lower.
Budget flexibility
Can you ride out higher payments if rates rise? Variables come with such a risk if the prime rate increases. That unpredictability could put strain on your finances. Fixed rates offer consistency, which helps with planning if you need to pinch pennies.
Interest rate predictions
Where do the experts think rates are headed? If they predict rises, locking in a fixed rate could save you money in the long run. But if the forecast suggests a decline, variable rates allow you to take advantage later. While timing the market can be challenging, reviewing rate forecasts can offer valuable insights.
Repayment terms
While the long-term economic outlook is uncertain, you can make decisions based on current conditions. This way, a variable-rate loan may suit you if you’re going to take out a loan for a short period of 2 to 6 months. Fixed rates are crucial for home purchases, while variable rates may be better suited for shorter-term debts.
Personal Loan Alternatives
If you’re going to buy a house, you may choose hybrid adjustable-rate mortgages (ARMs). These loans give you a set rate for the first handful of years and then switch to an adjustable rate. They’re kind of a mix between fixed and adjustable rates. They could be good if you want some stability upfront but don’t plan on keeping the loan forever.
Also, consider how long you want to stay in the house. If you know you’ll be there awhile, locking in a fixed rate for the whole loan makes sense. But if you sell it in a few years, an adjustable rate or hybrid ARM could work out better.
7 Tips for Saving on Loan Interest
You can lower your interest rate and save some money if you follow these tips:
- Make extra payments when you can. Even a little extra toward the principal will reduce the balance and interest charges over time.
- Refinance. If rates have dropped since you first got the loan, consider refinancing with a lower APR.
- Consolidate debt. If you have multiple high-rate loans, consider rolling them into one with a lower overall interest.
- Negotiate with the lender. Contact the lender to see if they can adjust the rate or terms. If you have a good payment history, they may be willing to accommodate you.
- Pay your bills on time. Late payments result in fees and penalties.
- Set up automatic payments so you never miss a payment. Lenders may offer a discount on your interest rate when you do this.
- Keep an eye on your credit score by managing debt carefully. Good credit means better rates on future loans, saving cash over time.
Bottom Line
Asking yourself, “Is a personal loan variable or fixed rate?” can lead to decision paralysis. That’s why, when choosing between a fixed or variable-rate personal loan, it’s important to weigh the pros and cons of both options.
Fixed-rate loans let you lock in payments, so budgeting is a breeze. However, variable-rate loans can start with lower costs, even if the payments increase later.
You are advised to look at your income situation, how steady it is, the whole interest rate scene, and how much you can handle payments bouncing. Doing all that makes it way easier to pick the right loan for your needs.
External sources:
- What is LIBOR – https://www.imf.org/external/pubs/ft/fandd/2012/12/pdf/basics.pdf
- National Rates and Rate Caps – https://www.fdic.gov/resources/bankers/national-rates/index.html
