Fixed vs. Variable Loans: Which Is Better for You?

Fixed-rate loans

A fixed-rate loan is a type of loan where the interest rate remains constant throughout the loan's term. This means that the payments are stable and predictable.

The advantage of fixed-rate loans is that you know exactly how much your payment will be each month. You also know how much interest you will pay over the life of the loan. This allows for long-term planning.

Fixed-rate loans are also advantageous during periods of rising interest rates. Since the rate doesn’t change, payments won’t increase if market rates climb. However, if interest rates drop, you will be locked into a higher rate.

Variable-rate loans

A variable-rate loan has an interest rate that can change over time, meaning your monthly payment can go up or down.

A benefit of a variable-rate loan is that it typically has a lower initial rate than a fixed-rate loan. These types of loans are also beneficial during economic times when interest rates are falling. If the market rates drop, the interest rate on the loan will follow suit.

A major drawback of variable-rate loans is that the payment is unpredictable, making it more difficult to plan for the future. Variable rates can change significantly over the life of a loan. In other words, your payments could look very different in five or 10 years. That unpredictability can make it harder to budget, especially if rates rise.

Fixed vs. variable-rate loans

Fixed and variable loans differ in how the interest rate is handled, with the primary impact being the effect on the minimum payment. With fixed-rate loans, the minimum payment remains stable throughout the life of the loan. With a variable-rate loan, the minimum payment changes every time the interest rate changes.

Fixed-rate loans are typically used in conjunction with installment loans, which have a predetermined end date, such as a car loan or a personal loan. Variable-rate loans are typically used with lines of credit, such as credit cards or home equity lines of credit.

If you have a choice in selecting the type of loan, consider your long-term plans. Matt Schwartz, a mortgage broker at VA Loan Network, explained, “Fixed-rate loans are good if you need stable monthly payments and plan to stay long term, but the rate is usually higher, and refi costs can sneak up later if rates fall.

“Variable loans start lower and work well if you plan to move or refi in a few years, but they can get risky fast if rates climb or your budget is tight.”

Which type of rate makes sense?

Fixed rates are best when you want steady payments. They're not ideal when rates are high and could fall soon.

Variable-rate loans make the most sense when rates are low and you know you can pay off the debt. They're not ideal when you need consistent, predictable payments.

When choosing a variable-rate loan, be sure to understand how often the interest rate can change — and by how much. For example, a variable-rate mortgage might have a fixed rate for five years and then adjust annually thereafter.

Lenders may offer different rates and terms based on your credit score, income and other qualification factors, which can influence whether a fixed or variable loan is the better fit.

Also, be sure to take note of the maximum rate. This is the highest rate your lender can charge, even if rates go up.

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What to consider when choosing a rate

When choosing between a fixed rate and a variable rate, consider your future plans. A fixed-rate loan may be better if you’re staying long term and meet typical loan requirements, like good credit and steady income. This type of loan offers long-term payment stability.

However, if you plan to pay off the loan quickly, either by making large payments or selling the asset, you may want to consider a variable-rate loan. These loans typically start with a lower interest rate, so if you can pay them off quickly, you benefit from that lower rate. Also, by paying off the loan quickly, you’ll have less time for the market to cause rate changes.

If you plan on moving or selling soon, a variable-rate loan might be the better choice.

You may also want to understand the interest rate environment at the time of your loan origination. If rates are unusually high, a variable-rate loan may let you take advantage of falling rates. However, the opposite is also true; if rates are low, you may want to lock in these low rates with a fixed-rate loan.

Tips on getting the right rate for you

When choosing a loan, carefully evaluate your financial situation and ensure you fully understand the loan terms. Also, be sure to run the numbers for both loan types so you’re making a fully informed decision.

If making the minimum payment on the loan will stretch your budget, you may want to consider a fixed-rate loan. The low starting rate on a variable loan can be tempting, but a fixed rate offers predictable payments, which helps if a rate hike would stretch your budget.

Variable-rate loans can have a variety of terms, and it's important to understand what you are being offered. Some variable-rate loans have a period during which the rate is fixed, followed by set periods when the rate can increase. For example, the rate may be fixed for five years, after which it can change every six months.

You’ll also want to know if the interest rate has a cap, and whether you could still afford the payments if it hits that limit.

Lastly, consider the larger economic environment. If rates are expected to drop, you may want to go with a variable loan to take advantage of falling rates. However, if rates are expected to rise, you may want to lock in a low fixed-rate loan.