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
Central banks change interest rates all the time. Sometimes up, sometimes down. Down when the economy is bad, up when inflation is high and joblessness low (those two usually go together too).
Banks and large scale financing companies (like car companies finance divisions), borrow money from those central banks, and then lend the money to you at a markup.
So in the US right now, the US fed rate is 5.33, and you can get a loan from bank of America for about 8.5% as their prime lending rate (many loans will be prime + X where X depends on the type of loan and your credit rating).
Now where do variable and fixed come in.
If you want a loan for the next 5 years (or 25) years, do you think in that time interest rates will go up, go down or mostly stay the same?
To make money the bank will offer you a fixed rate which is higher than the variable rate (say 9.5% vs 8.5). This has the advantage of you fixing your cost. You know what the loan will cost into the future.
But if you get a variable rate, when the prime rate changes your loan changes with it. Interest rates go down, you pay less, rates go up, you pay more. That’s risky, but the benefit is that you pay a lower interest rate than if interest rates stay the same or go down over time.
In general variable rate loans are cheaper than fixed rate ones. Yes, it hurts really badly when rates have shot up as quickly as they have post pandemic, but interest rates haven’t been consistently this high in 20 years. (they were this high in 2006 and 2007 briefly).
Latest Answers