May 18, 2022
When it comes to borrowing money, whether it's for a home mortgage or a personal loan, there are two types of interest rates that lenders typically offer: fixed and variable. Understanding the difference between these two types of interest rates is important because it can have a significant impact on your overall borrowing costs.
A fixed interest rate is exactly what it sounds like - it's an interest rate that stays the same throughout the life of the loan. This means that your monthly payment will be the same from the first payment to the last payment, regardless of any changes in the market interest rate. Fixed interest rates are often preferred by borrowers who value stability and predictability in their budgeting, as they can help you plan your finances more accurately.
One potential drawback of a fixed interest rate is that if market interest rates drop significantly after you've already taken out the loan, you may be stuck paying a higher interest rate than what's currently available. In this case, it may be worth considering refinancing your loan to take advantage of the lower interest rate.
Another potential drawback is that you may be limited as to how much you can repay in one year. Typically banks will only permit additional repayments in the amount of $15,000 to $20,000 per annum.
In Australia banks typically only offer a fixed term of 3-5 years whereas in the United States of America, it is quite common to find fixed rates of 25-30 years.
A variable interest rate, on the other hand, is an interest rate that can fluctuate over time. This means that your monthly payment can also vary depending on changes in the market interest rate. Variable interest rates are often tied to a benchmark rate, such as the official cash rate(OCR) set by the Reserve Bank of Australia, and will typically be expressed as the OCR rate plus or minus a certain percentage.
One potential advantage of a variable interest rate is that if market interest rates drop, your interest rate and monthly payment may decrease as well. However, it's important to note that your payment can also increase if interest rates rise, potentially making budgeting more challenging.
Variable interest rates may be more suitable for borrowers who are comfortable with a certain level of risk and who believe that interest rates are more likely to decrease than increase over the life of the loan. Borrowers who plan to pay off their loan quickly may also benefit from a variable interest rate since they will have less exposure to potential interest rate fluctuations.
When it comes to choosing between fixed and variable interest rates, there's no one-size-fits-all answer. The best choice for you will depend on your individual financial situation, your risk tolerance, and your future plans. If you value predictability and stability in your finances, a fixed interest rate may be the better choice. However, if you're comfortable with some level of risk and believe that interest rates are likely to stay low or decrease, a variable interest rate may be more suitable.
Ultimately, it's important to carefully consider your options and compare interest rates and terms from multiple lenders before making a decision. By doing so, you can ensure that you're getting the best possible deal and that you're choosing an interest rate that aligns with your financial goals and priorities.
