Applying for a loan may be as simple as a few clicks on a computer or deeply involved requiring you to come up with a considerable amount of documentation. Regardless the process, you go into it knowing what the interest rate is. That is, unless you have the option of choosing a variable rate loan. Let’s look at what the differences are between fixed and variable.
There are a couple other points worth noting on variable rates. First, some loans may start off at a fixed rate for a set period of time and then switch to variable based on economic conditions. Second, there may be limits on how far up, or down, a variable rate can move over time. The lender wants to avoid exposure to drastic swings in the markets and so they also limit the exposure of the borrower when the swing is in the lenders favor.
Which one do you choose? Much depends on the type of loan or credit extended, the length of the term, and the personal preferences of the borrower.
Let’s say you have an offer for a 30 year adjustable (variable) rate mortgage. You cannot predict the next 30 years but you may feel that if rates stay low over the next several years you can go for a variable rate mortgage and refinance.
The same conditions apply with acceptance of a credit card. You are not locked into a term for a credit card so if you feel that you can keep your balance low or pay it off quickly if rates rise then a variable rate credit card that can be unloaded quickly may be a worthwhile for you.
Finally, what are the personal preferences of the borrower? Many borrowers like the idea of being able to budget a fixed amount each month and do not want to keep track of market conditions that could cause rates to fluctuate.
It is important for all borrowers is to understand the differences between fixed and variable interest rates. If you decide to go with a variable rate, understand what triggers changes, when they are triggered and think about your options if they go too high for your budget.