Loans come in all shapes and sizes, whether they’re big long term home loans, or smaller short term personal loans. In all cases, a loan will come with an interest rate and you as the borrowed will be required to pay back more than you borrowed because of it. Lenders make money from that interest rate, but as a borrower you have a little bit of control of what you pay.
Fixed rates are (almost) exactly what they sound like, a fixed interest rate that doesn’t change. Fixed rates are often not offered for the full life of a mortgage, as 30 years is a long time, whereas they are more likely to be fixed for the life of a shorter loan. In many cases, the fees associated with the loan are ‘built in’ to the interest rate and won’t appear on your statement. Many companies will advertise an interest rate, and a comparison rate – the comparison rate helps see at a glance how the associated fees come into play.
Most lenders will set their fixed rate based off the current bank rate – in Australia they use the Reserve Bank of Australia, America has the Federal Reserve, and the UK has the Bank of England. While rates vary across the world there is also a global benchmark (LIBOR) which is used by some of the world leading banks.
While Fixed Rates are set based on the benchmarks at the time and do not change for the borrower after the loan was disbursed, variable interest rates can change on the whims of the banks. While they don’t often stray far from the benchmark – both to remain competitive, and to appeal to borrowers – there are minimal restrictions on banks raising rates, unless they were written into your original mortgage contract.
Occasionally your rate will be lowered if the benchmark rates go down, banks will often do this to discourage your from seeking out a better deal elsewhere.
The Best Option?
In the current environment of low interest rates, banks generally have higher fixed rates than variable rates. One theory is that by making the fixed rates higher, banks are intentionally making them unattractive to borrowers. This way, if the rates do go up in the future, banks will be able to raise the rates and increase their profit margin.
If you are on a fixed rate loan you have the confidence of knowing that your repayments won’t be going up in the near future. However, you are also going to be paying more than average if it’s a low interest environment.
There is no right or wrong choice when it comes to fixed or variable, it depends on your situation. If you are able to handle rates rising in the future, then a lower variable rate loan may be right for you. If you are stretching to make your repayments, then a fixed rate will give you the confidence that you’re rate won’t be going up when you can’t afford it.