title. i understand the difference between variable and fixed as definitions however with loans, ‘variable’ doesn’t quite register to me..
why on earth would someone consider that type of loan with a purchase of let’s say, a house?
In: 43
A variable rate isn’t truly a free variable, it’s usually tied to a benchmark, like the interest rates set by the Fed (or the central bank of another currency). If you have a variable rate loan, and your bank raises the interest rate much higher than the Fed rate, you can just go to another bank, and take out a loan to repay that loan.
Someone can loan you the money at a higher rate than the benchmark but lower than the one charged by your current bank. The amount you owe won’t change, and you got approved for the first loan, so it’s not any riskier to approve your new loan. Bank 1 will lose out on interest, Bank 2 makes a bit of profit with low downside risk. It’s similar to how people take out one time loans to pay off their credit card debt.
The advantage of variable rate is
1. It may be lower than fixed rate. A fixed rate loan has to factor in risk of inflation/rising rates, so it will typically be higher than the variable.
2. The variable may stay lower than the fixed rate the whole time or most of the time. It can even drop lower than it started. You’re betting on the future.
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