Fixed vs. Variable Rate Personal Loans: Which Is Better?
When getting a personal loan, there are some important things to consider, starting with:
- What credit score is needed for a personal loan?
- How much can I borrow?
- What’s the best place to get a personal loan?
Personal loan interest rates also matter, since a lower rate can save you money. And it’s important to weigh fixed rate personal loans against variable rate personal loans before making a decision.
What is better, fixed or variable personal loan? Here’s more on how they work to help you decide.
What Is a Fixed Rate Personal Loan?
Fixed rate loans, including fixed rate personal loans, have a set interest rate. This interest rate is spelled out in your loan terms and it doesn’t change for the life of the loan.
For example, say you’re approved for a $20,000 personal loan at 6%, with a five-year repayment term. You’ll pay that same 6% rate for the entire five years, assuming you don’t pay the loan off early. And your monthly payment will always be the same with a fixed rate loan.
What Is a Variable Rate Personal Loan?
Variable rate loans have an interest rate that can change over time. Variable rate personal loans tie their interest rate to a benchmark or index rate, such as the LIBOR (London Interbank Offered Rate).
As the underlying benchmark or index rate increases or decreases due to changing market conditions, the interest rate on the loan fluctuates as well. As the interest rate changes, the monthly payment can increase or decrease as well.
Variable rate personal loans typically set a cap on the maximum rate you’ll pay. Even if the index or benchmark rate continues to increase, you won’t pay more than the cap rate.
Fixed Rate Personal Loans: Pros and Cons
Fixed rate personal loans can be useful in a variety of scenarios. For example, you may get a fixed rate loan to consolidate debt, pay for home improvements or fund an emergency expense.
As you consider fixed rate personal loans, keep these advantages and disadvantages in mind.
- Predictable monthly payments
- Easily calculate the total amount of interest you’ll pay
- You don’t have to worry about your rate increasing
- Variable rate loans could offer more interest savings when rates are low
- Monthly payments may be higher than variable rate loans
Variable Rate Personal Loans: Pros and Cons
Variable rate personal loans can be used in the same ways as fixed rate loans. The key difference lies in how interest is applied.
Here’s how the advantages and disadvantages of variable rate loans compare.
- Potential savings on interest if rates remain low
- Monthly payments may be lower compared to a fixed rate loan
- Rate caps offer some predictability about the maximum rate you’ll pay
- Payments can fluctuate, making budgeting more difficult
- Interest rates may start off low, then significantly increase
Which Is Better: Fixed Interest Rate or Variable Rate Loans?
Both fixed rate and variable rate personal loans can help meet your financial needs but it’s important to consider when it makes sense to use one versus the other. When interest rates are low, for example, a variable rate loan can be attractive if the initial rate is lower than what you’d pay with a fixed rate loan.
But it’s important to remember that low interest rates can gradually increase, meaning a higher rate for you down the line as well as a higher monthly payment. Estimating what your monthly payment might be under the cap rate can help you determine whether the loan would still be affordable.
Fixed rate loans give you more predictability with budgeting because you’ll always have the same payment. The trade-off is potentially paying more in interest charges over the life of the loan, compared to a variable rate option.
Paying a fixed rate personal loan off early could help to minimize the total interest paid. But be aware that a lender can charge a prepayment penalty for doing so. This penalty is designed to help the lender recoup some of the interest charges they’ll miss out on if you pay the loan off ahead of schedule.
RELATED: How to Cut Your Debt by 50% in 6 Months
How to Manage Personal Loan Repayment
When taking out a personal loan, it’s important to have a repayment strategy. These tips can help you stay on top of the debt:
- Pay on time or early each month
- Ask about an interest rate discount for enrolling in automatic payments
- Consider doubling up on monthly payments to reduce debt faster
- Estimate any prepayment penalty you may owe for paying the loan off early
If you have a variable rate loan and the rate is set to increase substantially, consider refinancing. It’s possible to refinance a variable personal loan into a fixed rate loan to save on interest charges while reducing your monthly payment. Take time to compare personal loans online to find the best refinancing rates.
What to know about paying off debt and getting your finances back on track
Rebecca Lake is a freelance writer specializing in personal finance,
credit and debt. She’s a contributor to U.S. News and World Report,
Forbes Advisor and The Balance and her work has appeared online at CreditCards.com,
Money-Rates.com and dozens of other top publications.