When you take out a loan for a car, home, education, or something else, you’ll need to consider the terms of that debt.
One of the most important considerations is the loan’s type of interest rate.
Almost everyone requires some financing at some point in their life.
A loan has some advantages and is an essential part of life for most people. It could be taken to buy a new house or car, fund your child’s education, start a business, or even pay unexpected expenses like a medical bill or insurance.
I’ll explain the benefits and challenges faced when taking out either option.
What are Fixed Interest Rate Loans?
They are cash advancements that have a set interest rate for the entire duration of the repayments. When you take out one, you know exactly what your monthly payments will be for the life of the loan.
They can be very beneficial for borrowers who want to lock in an amount and don’t want to deal with fluctuating rates.
Carrying a fixed interest rate means that the loan term’s annual percentage rate (APR) stays the same.
However, they can also be difficult for those that need to make large lump sum payments each month (such as with home equity lines of credit).
These loans are not always suitable for everyone. So, discussing your options with a good financial professional is important before taking out any type of credit.
What are Variable Interest Rate Loans?
There are many different ways a variable interest rate can be structured. One of the most common forms is an adjustable-rate mortgage (ARM). ARMs typically have a fixed interest rate for the first few years and then adjust regularly.
The interest rate on an ARM is often set by reference to a benchmark index such as the London Interbank Offered Rate (LIBOR), which means that if the LIBOR goes up, so will the ARM.
The other major way a variable interest rate can be structured is with a floating-rate loan. This type of loan will have an interest rate that changes over time based on market conditions, like how many people require money or how much competition there is for long-term loans.
While you might assume that getting a variable-interest-rate loan would save you money in the long run, it costs more because you’ll pay extra each month in interest charges. So it’s important to research before taking out such a loan to know what you’re getting yourself into.
What Other Types of Credit Are There?
This depends on the type of person you are and the financial situation you might be in.
Taking out a loan shouldn’t be the first thing you decide to do unless you know how to manage your business money.
Take a look at other credit options and how they differ from the rest:
1. Student Loans
You can take out student loans in many ways, such as through the federal government’s direct loan program, private lenders, and credit unions.
These are tailored for students. So when you graduate, you’ll usually have to repay your loan in one of two ways.
This is done either by making monthly or shorter payments but with more interest over time.
2. Credit Unions
Credit unions operate on a membership basis and typically provide low-cost loans to their members.
They also offer savings accounts and many other financial services.
Credit unions are owned by their members and are democratically governed by elected representatives of the membership (the board of directors).
Credit unions are not-for-profit and exist solely to serve the interests of their members.
3. Private Lenders
These lenders are known to provide loans at higher interest rates since the requirements for taking out one are far from strict.
Private lenders offer loans of different types, such as unsecured personal loans, secured personal loans, and business loans.
They also have different lending criteria, such as minimum loan amounts, interest rates, and other requirements.
Fixed Interest Rate: Pros and Cons
If you have a good credit score and a steady income, then a fixed-interest loan could be the perfect solution to avoid cash flow problems.
This means that the interest rate won’t increase or decrease during the life of the loan. There are some advantages to getting a fixed interest loan:
- You can get a loan with a low-interest rate.
- Your monthly payment will be predictable.
- It is less likely that you will default on your loan.
- It may result in savings that can be used for other expenses.
On the other hand, there are some disadvantages to getting a fixed-interest loan. The interest rate will be locked in until you pay off the entire balance of the loan. This means that you would need to make large payments towards the end of the loan term to lower your monthly payment.
If you change jobs, you will have to pay penalty fees and early repayment fees, depending on your current employer’s policy.
Variable Interest Rate: Pros and Cons
It’s a good idea to plan for a long-term investment when considering a variable interest rate loan.
While these cash advances are usually tailored to overcome financial problems in businesses, they can also help facilitate a worthwhile project that needs financial backing.
If the ends justify the means, then there’s no reason why you shouldn’t take out one if it assists your venture in the long run.
The downside is that your investment is dictated by the market itself, which could either move to your benefit or not. This is especially problematic if the borrowed amount is a large sum and interest rates decide to skyrocket because of fluctuations.
There are major risks involved, such as loss in capital, assets, time, and effort invested. The longer the repayment term, the higher the risk.
Fixed vs Variable: Which Is Better?
Fixed-rate loans are typically cheaper in monthly repayments, but they have higher interest rates attached. Variable-rate loans are more expensive in this regard but offer lower interest rates.
In general, it is best to choose variable rate loans if you can afford your interest rate going up over time. On the other hand, if you expect your interest rate to remain steady or to go down, then it might be better to choose a fixed-rate loan.
One of the main advantages of a variable-rate loan is that it lets you take advantage of low rates while also giving you the flexibility to adjust your payments as needed. For example, if your job suddenly becomes more stressful and you cannot make an extra monthly payment, then you can pay a little more one month to get back on track.
A great advantage of fixed-rate loans is that if you’re planning to buy a house, this loan might save you thousands in interest payments over the life of your mortgage.
All institutions that offer credit have different rates and conditions, so it’s a good idea to do proper research before proceeding.
17 MONEY MANAGEMENT SKILLS YOU NEED AS A LOW-INCOME EARNER
When first thinking about financing your home, or any other large purchase, it can be tricky to know the best way forward.
Many different financing options are available, each of which has pros and cons. Depending on your financial situation and needs, one type of financing will likely be more beneficial than another.
There are many types available to choose from. This includes online institutions as well as overseas lenders that are ready to assist.
Weighing out your options and doing background checks will ensure that your odds of failure will be close to zero.