As financial industry is growing, demand for various goods and services are increasing. Increasing demand is not always met through disposable income. Sometimes people tend to spend more than they actually can. Here comes opportunity for loans.It’s not only personal loan which is relevant and in demand, but other financial products custom made by banks is a high utility product for every buyer.
Interest rate is considered the most important variable while choosing a loan. Thus, understanding interest rates is important. Primarily, there are two types of interest rates: Fixed and Variable.
Fixed interest rate remains constant at predetermined rate, throughout the term of the loan. No matter what the current rates are. It is decided at the time of loan’s approval. They are based on market rates prevailing at the time of loan or based on the credit rating of customer.
Variable or changing interest rates, as name suggests, change over the life span of the loan. It fluctuates because it is decided by an underlying bench mark interest rate and index that fluctuates time to time. It is largely dependent upon market rates which go up and downs. Your payments too changes with such changes.
If you are ready for a loan on variable interest rate, initial interest rate is usually lower than the prevailing fixed interest rate of same loan amount. This initial rate will remain fixed for a predetermined time, which is known as ‘introductory period’.
After this period is over, the variable rates will fluctuate according to changes in the market. Usually, this type of loan is secured by a cap, it draws an upper limit to interest rate bank can charge.
At the introductory period, variable interest rates remain quite lower than fixed interest rate. As a result, your payments to the loans come down substantially. With the lower payments, you will find it is easy to repay loan and save on payment you are making to write off the loan.
If market rates continue to remain low, variable interest rate payment will stay considerably low. You could save more money, which otherwise could have gone into repayments. As rates come down, saved amount can be used to pay off principal amount. It will help you paying off entire loan faster. In addition, variable rates offer more flexible options regarding length of the loan.
However, variable rate are highly unpredictable. Customer can be caught in difficulties because it is difficult to calculate or plan the payments on a prior basis. With such fluctuation, they can’t plan the future in advance.
If prevailing market rates goes up, the interest rate on loan will go up as well. Sometimes payments are much higher than the affordability of customer. As a result, payments to variable rates become much higher than that of fixed rates.
Variable rates include tough jargon which makes it more difficult to understand.
Generally, it is good to choose fixed rate if market rates are much lower and there is an expectation of rise in the market rates. On the other hand if market rate are showing downturn, then it would be better to choose for variable rates. Variable rates are also advisable if borrower is looking for a short term loan.