We’ve all been in the situation: You’re borrowing money and want to make sure you pay back what you owe. But at the same time, a higher interest rate could save more money on your loan.
So which is better? In this article, we’ll explore some of the pros and cons of fixed- and floating-rate loans to understand which type of personal loan works best for your needs.
What Is an Interest Rate?
Every time you take out a loan, the licensed moneylender will charge interest, the amount of money they want you to pay them for borrowing your money.
Interest rates are typically expressed as an annual percentage rate (APR), which means that if your loan has a fixed interest rate and it’s 10%, then your monthly payment would be $100 plus 10% of that amount ($10).
In this article, we’ll look at how fixed vs floating personal loans work, their advantages and disadvantages, and how to calculate the monthly payments on each type of loan.
Why Are There Different Types of Interest Rates?
As you probably know, interest rates determine how much money will be paid back to the lender.
The borrower’s monthly payment is based on the principal amount borrowed and the amount of interest that accrues each month.
This article aims to help you understand how different types of fixed and floating interest rates work so that you can better understand their advantages and disadvantages.
What Is a Fixed Interest Rate?
A fixed interest rate is a rate that does not change over the life of your loan. Fixed rates are typically higher than variable rates, but there are some benefits to choosing one over the other.
You’ll notice that many mortgages and car loans have fixed rates, while credit cards and personal loans offer variable rates.
The type of loan you choose will depend on your unique financial situation and what you want.
Advantages of a Fixed Interest Rate
Fixed interest rates are predictable. You can see how much you will be paying for your loan, in addition to what the total payment will be. This is important for those who want to make a budget and stick to it.
Fixed interest rates are lower than variable rates. If you know that there is a chance that your income could change in the future, then having a fixed rate could help keep costs down if they do change while still allowing you access to funds when needed.
Fixed RIses Are Good For Those Who Want To Know Exactly How Much They Will Be Paying And Stick To A Budget.
Disadvantages of a Fixed Interest Rate
If you choose a fixed interest rate and the bank raises rates in the future, your payments will remain the same.
You will not have any leverage when negotiating with the bank because they have all the power in this situation.
The same goes for lowering your payment amount if interest rates drop—you will not be able to take advantage of those lower rates since it’s already locked in for you at that higher cost over time.
The next disadvantage is that if you want or need more money from your loan in the future, it could be difficult or impossible because of its predetermined nature (again, due to limited negotiation).
And finally, if interest rates drop dramatically after you lock into an initial term and pay off what was initially agreed upon at higher costs than expected (and then use them again), then this can mean paying more overall for taking out those loans than had someone else been able to get better deals on their terms later on down the road – especially now that we’ve seen such dramatic swings within just last few years alone.
What Is a Floating or Variable Interest Rate?
If you’ve ever taken out a loan, you may be familiar with the concept of an interest rate.
The interest rate is the amount your lender charges as compensation for borrowing their money. With personal loans, getting a fixed or floating rate option is possible.
You can think of fixed-rate loans as more traditional in that they have a set interest rate for the life of the loan agreement.
A variable-rate loan has an introductory period after which its interest rate can change based on market conditions like inflation and other economic factors.
The advantage to variable rates is that they typically start at a lower base rate than fixed ones do—but there are also risks associated with varying rates if your credit score is not good enough to qualify for them (which means higher monthly payments).
Advantages of a Floating Interest Rate
Flexibility: A floating-rate loan is more flexible than a fixed-rate loan, so you can take advantage of lower interest rates when available.
This is particularly useful if you are planning to borrow money for an investment in your business or purchase real estate property.
Ease of budgeting: With a floating rate account, it’s easier to set up proper budgeting and spending plans because your monthly payment will change as market conditions do—meaning that you’ll have more control over how much money goes out each month without having to worry about fluctuations in interest rates or unexpected rate hikes from the bank’s end.
Disadvantages of a Floating Interest Rate
The interest rate on a floating-rate loan can change at any time. While this may sound like an advantage, it has some severe drawbacks:
You might be able to pay off your loan more quickly than expected, but the interest rate will increase and make your payments higher. If that happens, you could pay more in the long run than if you had taken out a fixed-rate loan with no increases.
It’s also possible that rates will go down after taking out a floating-rate personal loan, which means your monthly payment will increase even though it’s staying at the same level as before! That would mean paying more for longer—and being unable to pay off your debt quickly.
We hope this article has helped you understand the differences between fixed and floating interest rates. As we discussed, they both have their pros and cons.
If you have a short-term loan that will be paid off quickly (like buying an appliance), then it might make sense to choose a variable rate.
But if you plan on paying off your debt slowly over time (like buying a house), then choosing a fixed interest rate could keep more money in your pocket, thanks to lower monthly payments.