It can be difficult to choose a loan at all and there are all sorts of decisions that we have to make in order to pick between them. If you are borrowing a large sum of money, then you may have the option of choosing a fixed or variable rate and this can be difficult to do. It is worth understanding what the two loan types are and what the main differences are between them, so that you can make a decision.
What are fixed rate loans
A fixed rate loan will have the same interest rate, either for the full term of the loan or for a certain period of it. This means that when you sign up you will know what the rate is and it will not change at all or until a certain time period is up. You will therefore know exactly how much you will have to repay each month as this will be fixed. You may be tied into the loan, meaning that if you want to swap to a variable rate during the fixed rate period you may have to pay a fee and if you want to swap to another lender you may have to pay an even larger fee. This will vary between lenders though and is something that you should check out before you sign any documents.
What are variable rate loans?
A variable rate loan will have an interest rate that can vary. This means that the lender can change it whenever they like. They will want to stay competitive though as you are normally not tied in so could move to a cheaper lender if they put theirs up to an unreasonable rate. However, if the Bank of England base rate goes up then they will probably put their rates up as most lenders would tend to do the same things. If the rates go down they may but their rates down but quite often lenders do not always do this. The exception to this is a tracker rate, which will track the base rate and then any rises or falls in the rate will be reflected immediately in what you are paying.
Advantages of fixed rate loans
Many people like the fixed rate loan because they know exactly how much they will be repaying, at least for a certain period anyway. If they are worried that rates going up will make it a struggle to make their repayments, then having a fixed rate will protect them from this. Often this is used on a mortgage for first time buyers who may not have lots of money to spare to repay their mortgage and they are concerned that rate increases may make it impossible for them to afford the repayments. If the interest rates do increase significantly then the fixed rate will be a good idea as it will protect the borrower from those increases.
Advantages of variable rate loans
Coming off a fixed rate loan to a variable rate can be difficult if the rate suddenly increases and this will not happen with a variable rate loan. A fixed rate loan can often be expensive as the interest rate is usually set higher than the variable rate. If the Bank of England base rates decrease, then those on a variable rate may find that they get to repay less interest but on a fixed rate this will not happen so you could end up paying a lot more than you would have done on a variable rate. You tend not to be tied in to a variable rate and therefore you can move to a different lender if you feel that you are paying too much and they are cheaper. You do need to be aware of any fees you might have to pay to do this.
It is quite tricky to decide though. It is almost impossible to predict interest rate change, particularly in the long term so you are making quite a gamble. You may feel that if rates are low then they are more likely to rise but if they are high, they are more likely to fall. However, it all depends on the term of the loan as to whether any significant changes are likely to happen before you repay it. If you want to feel secure in knowing you will be able afford the repayments then fixing the rate can be sensible, but if can afford to pay a bit more if necessary and feel you want to be able to take advantage of any possible reductions in rates then a variable rate might suit you better. Each individual is different though and so you will need to think about which will suit you the best considering the circumstances that you are in.