Interest, as the price of capital, can be a crucial factor in a decision to get a loan for your house, car or any other merchandise. Interest is especially important in long term loans. Since very small amplitudes in interest can bring the total payment to be drastically impacted. Loans can generally be divided into loans with fixed interest and loans with a fluctuating interest rate. Since long term loans have much longer repayment periods, a change in interest which is measured in decimals can be very substantial and bring the total payment to much higher levels.
Any loan in which the interest rate does not change during the repayment period is called a fixed interest rate loan. The borrower can, because of this fact, very precisely predict all of the future payments. That’s because all of his payments will be the same over the entire term of the loan, no matter how the market behaves. If the interest rate is variable, we are talking about a variable or fluctuating rate loans. These are tied to the discount rate (the rate at which financial institutions borrow money from the central bank, usually on a short-term basis).
If the lender is under the impression, based on his knowledge, research and experience, that he can predict the fluctuation of the discount rate in the future, he will be able to make a decision whether to loan his capital under the fixed interest regime or the fluctuating interest rates. When a loan is a fixed interest rate loan and the discount rate is at an all-time low, it will be reasonable to expect that the discount rate is going to rise and, thus, the fixed rate will be higher.
On the other hand, if the discount rate is high, the lender will offer his capital with a lower fixed interest rate, as the discount rate is likely to fall in the future. So, whether a fixed or a variable interest is better for you will depend on the financial enviroment at the time the loan is taken and the duration of the loan. Also, other factors will influence this: different personal factors like borrower’s family and employment status.
Fixed rate loans
Capital rates of fixed rate loans are usually formed as a function of promised interest rates in the moment of calculation. These loans, because of this, always carry a capital risk. This means that if the interest rates fall in the future, the capital value of the loan will rise. With a variable rate loan, capital value of a loan will always be the value of the original loan minus any capital repayments.
These facts can sometimes produce results which are, on first thought, counter-intuitive. However, studies have shown that you are more likely to pay less overall with a variable rate loan than with a fixed one. In the end, it is wise to consult a financial professional and gather as much information as possible before making this important decision.