The difference between a fixed interest rate and a variable interest rate primarily lies in how the interest is applied over the term of the loan.
Fixed Interest Rate
A fixed interest rate remains constant throughout the entire term of the loan, regardless of changes in market conditions. This means that your monthly payments will not fluctuate, providing stability and predictability.
- Advantages:
- Predictability: Borrowers can easily budget their finances since payments remain the same.
- Protection Against Rate Increases: If market interest rates rise, borrowers with fixed rates are unaffected, potentially saving money over time.
- Disadvantages:
- Higher Initial Rates: Fixed rates are often higher than initial variable rates, which can lead to higher overall costs if market rates decrease.
Variable Interest Rate
A variable interest rate can change periodically based on an underlying benchmark rate, such as the lender's prime rate or other economic indicators. This means that monthly payments can increase or decrease over time.
- Advantages:
- Lower Initial Rates: Variable rates typically start lower than fixed rates, making initial payments more affordable.
- Potential for Decreased Payments: If market rates decline, borrowers may benefit from lower monthly payments.
- Disadvantages:
- Uncertainty: Monthly payments can increase if market rates rise, making it harder to budget for future expenses.
- Risk of Higher Costs: Over time, variable-rate loans may become more expensive than fixed-rate loans if interest rates rise significantly.