When we look at interest rates, whether they are on loans or savings accounts, we will often notice that we have the option of either fixed or variable rates of interest. These can be rather confusing. It is a good idea to understand what they mean and how they should impact us when we are deciding which to go for.
What are Fixed and Variable Rates?
A fixed rate is a rate of interest which stays the same. This might be for the full term of the product or it might be for some of the time. Normally with a savings account it will be for the full term of the product. With a loan, it would possibly be only for some of the time but it will depend on the type of loan. With a mortgage it is likely to just be for a few years, but with a payday loan it will be for the whole term. There are pros and cons to each way of charging interest.
What are the Advantages of Each?
Having a fixed rate of interest means that you know exactly what to expect. So, whether you are making repayments on a loan or receiving interest on your savings, you will know how much you are going to get. For a loan, if you think that you will struggle if the repayments are any higher, then knowing that interest rate is fixed and cannot possibly go up, will be very helpful. With a savings account, if the interest rate seems pretty high, then knowing that it cannot go down can be good. It can be hard to find a good savings rate and if you have found a good one that is fixed then this could be a great thing.
What are the Disadvantages of Each?
With a fixed rate, it means that it cannot change. So, if interest rates go up and you have a fixed rate savings account, you will not be able to benefit from that rate increase. If you have a loan and the rates go down then you will not be able to benefit from the reduction.
Therefore, you will have to make a decision as to whether the stability of a fixed rate will suit you or whether you will be better off with a variable rate where you will take a risk but could benefit more. It could be that it is worth thinking about whether you feel that the interest rates are likely to change as well and if so, in what direction you think they might change in. If you have a loan and fear they will go up then perhaps you will want to go with a fixed rate to protect you form those changes. However, if you have a savings account you might be happy to have a variable rate and hope that it goes up. However, if rates are likely to fall you may want a fixed rate on your savings so that you do not see a drop but for a loan you may want to stick with the variable rate in the hope that it might fall. It can be very hard to predict what might happen, although the long term is much harder than the short term. Make sure that you plan for the worst with regards to loan repayments though. Imagine interest rates will go up and think about how well you will cope with that. If you fear you will not cope then it could be safer to go with a fixed rate. The same goes for savings in the sense that if you are relying on the interest for income, then make sure that you are able to cope with that amount going down if the rates fall and if you are not then perhaps find a fixed rate to secure it.