Variable Vs Fixed Rates: Implications In A Low-Rate Environment

When borrowing money, choosing between a variable and fixed interest rate can feel like walking a tightrope. 

Do you want the predictability of a fixed rate or are you willing to gamble a bit with a variable rate that could save you money? This decision gets even more complicated in anticipation of upcoming Fed interest rate cuts. 

Now that experts expect interest rates to decline, should you opt for variable vs fixed rates? We’re going over key things to consider to help you make a decision. 

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MoneyLion can help you explore a wide range of loan options tailored to your needs, whether you’re into the certainty of fixed rates or the potential savings of variable rates.

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Should you choose between variable vs fixed rates as the Fed cut rates?

As you shop for financing and consider variable vs fixed rates, it’s critical to also take into account possible upcoming Fed interest rate cuts. Slashes in interest rates ultimately impact the cost of borrowing consumers face, which means that the decision between fixed or variable rates could have a significant impact on your monthly payment. 

Variable interest rates fluctuate over time. When interest rates are falling, variable rates can offer substantial savings. Fixed interest rates, on the other hand, remain constant throughout the loan term. 

The decision between variable and fixed rates depends on your individual circumstances and risk tolerance. If you feel confident that interest rates will fall or if you plan to pay off the loan quickly, a variable rate might be a good option. However, if you’re concerned about potential interest rate increases or if you prefer the stability of a fixed rate, it might be a better choice.

The decision is not an easy one and will ultimately depend on your specific financial situation. If you’re unsure, it may be helpful to consult with a financial advisor to go over the pros and cons of each option.

What is a variable interest rate loan?

A variable-interest rate loan is a loan whose interest rate can change over time. The rate is typically tied to a benchmark, like the prime rate or LIBOR, meaning it fluctuates with the broader market. As the rate goes up or down, so do your monthly payments. Variable-rate loans are common in credit cards, mortgages and personal loans, offering potential savings if rates decrease but also posing risks if they rise.

How do variable interest rates work?

Variable rates start with a base rate, like the prime rate, plus a margin set by the lender. For example, if the base rate is 3% and the lender adds a 2% margin, your starting interest rate will be 5%. As the base rate fluctuates, so does your loan’s interest rate. If the base rate rises to 4%, your new interest rate would be 6%.

How often do variable rates change?

Depending on your loan terms, variable rates can change as frequently as monthly or quarterly. Changes are typically triggered by shifts in the broader economy, such as the Federal Reserve adjusting interest rates. This means your payments could rise or fall several times throughout the life of your loan.

Variable rate loan pros and cons

Variable interest rates have pros and cons; weighing both sides before committing is important.

Pros: • Variable rates tend to start lower than fixed rates, offering short-term savings. • If interest rates drop, your payments could decrease. • Flexible repayment options can allow for adjustments if rates get too high.

Cons: • Unpredictable rate changes can lead to higher payments over time. • More difficult to budget due to fluctuating payments. • Potential for rates to rise significantly, increasing overall loan costs.

What is a fixed-interest rate loan?

A fixed-interest rate loan locks your interest rate for the entire loan term. This means that no matter what happens in the economy or with interest rates, your rate—and monthly payment—stays the same. Fixed-rate loans are common in mortgages, car loans and personal loans, providing financial security and predictability.

Can a fixed interest rate change?

In most cases, fixed interest rates do not change. Once you lock in the rate, it remains the same for the duration of the loan. Some loans come with adjustable features after a certain period. For example, a fixed-rate mortgage might convert to a variable rate after five or seven years. Always read the fine print.

Fixed-rate loan pros and cons

Fixed-rate loans also come with their own set of benefits and drawbacks.

Pros: • Payments are predictable, making it easier to budget. • Protection from rising interest rates over time. • Stability is ideal for long-term loans like mortgages.

Cons: • Fixed rates tend to start higher than variable rates. • You won’t benefit from any drop in interest rates. • Less flexibility if financial markets change in your favor.

Variable rate vs. fixed rate: Which is better?

Several factors come into play when choosing between a variable and a fixed rate. Here’s what you need to consider.

• Interest rate stability: Fixed rates provide stability and predictability, while variable rates can fluctuate with the market, making them less stable but potentially cheaper in the short term.
• Timing of interest rate changes: Variable rates can change monthly or quarterly, while fixed rates stay the same throughout the loan. If you plan to repay the loan quickly, a variable rate might save you money before rates rise.
• Loan term: For short-term loans, variable rates might be better, as you can capitalize on lower initial rates. Fixed rates offer peace of mind over the years for long-term loans like mortgages.
• Risk tolerance: A variable rate might work for you if you’re comfortable with some risk and can handle fluctuating payments. However, a fixed rate is the safer bet if you want financial security.
• Current and projected interest rate environment: If rates are expected to rise, locking in a fixed rate could protect you from paying more. If rates are projected to fall, a variable rate might save you money in the long term.
• Overall cost: Variable rates tend to start lower but can increase, making them more expensive if rates rise. Fixed rates offer predictability, but you might pay a premium for that stability.

Fixed or variable – what’s the right call?

When deciding between variable and fixed-rate loans, it all comes down to your financial situation and risk tolerance. If you want peace of mind and stable payments, a fixed rate may be the way. A variable rate might offer short-term savings if you can afford potential fluctuations. The key is to evaluate your goals and the current market before deciding.

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