The Cons of Fixed Rate Loans
Like many financial products, fixed rate loans have aspects that may make them a poor choice for some borrowers. Some of these are:
- Rates never decrease: Fixed interest rates are great when market rates rise but less beneficial when they decline. Being locked into a fixed rate means your loan’s interest rate never decreases.
- Higher interest rates: Historically, fixed interest rates have usually been higher on average than variable interest rates. This means borrowers will usually pay more interest overall on a fixed rate loan when compared to a variable loan.
Variable Rate Loans
A variable interest rate loan is one in which market changes influence the interest rates levied by the lender. The interest rate may increase or decrease throughout the loan term and may result in correspondingly higher or lower monthly payments.
The loan's interest typically ties back to a reference rate or benchmark index, such as the prime or federal funds rates. These benchmarks give lenders a base interest rate to which they may add a margin. Lenders will usually add the base interest rate and the margin together when calculating the interest rate to offer borrowers.
Types of Variable Rate Loans
You may know that credit cards and lines of credit have variable interest rates, but variable rate loans can also include products like:
- Adjustable-rate mortgage (ARM): This type of variable interest mortgage gives you the benefit of an initial rate that remains fixed for a certain period before a variable rate is implemented. However, keep in mind that other loans may not work the same way.
- Variable rate personal loans: Some lenders also offer personal loans with a variable rate, though these may be less common.
The Pros of Variable Rate Loans
Variable rate loans have upsides that make them attractive to some borrowers. They may offer benefits such as:
- Monthly payments may decrease: The primary benefit of variable rates is that your monthly payments decrease when the market interest rates decrease. This shift can help reduce your overall expenditure on interest and may help you save more.
- Variable rates may be lower than fixed rates: Since the borrower incurs more risk with a variable rate loan, lenders usually offer comparatively lower rates.
- Initial rate period: Some lenders may offer a low introductory rate on certain loans, such as ARMs, that may last a few months or years. So, you would pay a lower interest rate during this promotional period.
The Cons of Variable Rate Loans
Anyone considering applying for a variable rate loan should also consider its downsides. Variable rate loans may have drawbacks such as:
- Rising monthly payments: Monthly loan payments may increase when market interest rates rise. Even minor increases can affect your monthly payments and, therefore, your overall finances and budget.
- Risk of defaulting: A sudden hike in interest rates may increase your monthly payment to the point where you can't pay it back and risk defaulting.
- Monthly budgeting could be harder: Not knowing if your monthly payments will increase might make it more challenging to plan your long-term finances.
How do I choose between a fixed rate and a variable rate loan?
There are some important factors to consider when choosing between fixed and variable rate loans. You'll need to look at your financial situation to make a proper decision.
Purpose of the Loan
Your choice between a variable and fixed rate loan may depend on how you intend to use the loan. If you’re buying a house, some lenders may offer you a choice between fixed and variable rate loans. However, if you need a personal loan for a household emergency or are looking for a car loan, you may have a harder time finding a lender willing to give you a variable rate loan.
Interest Rates
Nobody can predict whether interest rates will rise or fall, but you may be able to use the current rates and market as a guide. If interest rates have been steadily rising, a fixed rate loan may be the better alternative. Similarly, if rates have declined, you may benefit from a variable rate.
Choose the best loan for you
When you’re considering the benefits of fixed rate loans vs. variable rate loans, the key deciding factors are your own needs and market research. You may want to note interest trends, the possibility of prepayment fees, the purpose of the loan and the availability of certain loans before deciding.
No matter what you choose, remember to compare rates, fees and terms as much as you can before submitting a formal application.
Citi offers personal loans to both existing Citi customers and new Citi customers that meet specific eligibility criteria, including an established credit and income history along with additional factors determined by Citi. If you think you could benefit from a Citi Personal Loan, apply online today.
This article is for general educational purposes. It is not intended to provide financial. It also is not intended to describe any Citi product or service. You should refer to the terms and conditions financial institutions provide for various products.
