The main differences between fixed rates and variable rates are how the rate fluctuates and how it alters your repayment amount and overall cost of lending. Various types of loans can have either a fixed or variable rate, and depending on your business needs, either rate option may be applicable. By understanding how both rate types work, you can determine borrowing costs and how to manage repayment expectations.
Key Takeaways:
- Variable rates are subject to increase or decrease based on current market conditions.
- Fixed rates have the same rate of interest throughout a financing term.
- Both options are calculated using a benchmark index rate and basis point? margin.
What Are Fixed vs Variable Rates?
Fixed interest rates are applicable to financing options that will have the same rate of interest throughout the financing term. Essentially, the rate remains constant, and the repayment amount required—usually with principal and interest—is paid in equal installments until maturity.
In a favorable market, fixed rates may be low and therefore allow for an affordable repayment schedule throughout the life of the loan. The opposite can be said in the case of a market downturn, as rates may increase and you might be stuck with a high interest rate over the course of a loan, resulting in higher repayment amounts and overall lending costs.
Meanwhile, variable interest rates—also commonly known as adjustable or floating rates—are used when a financing agreement has a rate that can be adjusted throughout the term. This means that rates can increase or decrease based on market conditions and that the expected repayment amount can change based on the current rate.
Variable rates are more common with short-term financing options and can be useful in favorable market conditions when rates are low and save money in overall financing costs. That said, variable rates tend to pose more risk to the borrower since they are less predictable.
How Do Fixed vs Variable Rates Work?
Pros & Cons of Fixed & Variable Rates
Fixed Rate | |
Pros | Cons |
You’ll know exactly how much you are expected to repay monthly. | Your monthly payments could be more expensive compared with variable interest rates. |
You’ll be protected from variable market conditions impacting the fluctuation of interest rates. | Fixed rate loans typically have longer repayment terms, making costs of financing more expensive overall. |
You can take advantage of being locked in to affordable rates when market conditions are favorable. | You’ll have lesser flexibility with loan terms with a fixed rate financing agreement. |
Variable Rate | |
Pros | Cons |
Rates can be cost effective and suitable for short-term financing needs. | Rates are subject to change at any given time to align with current market conditions. |
Borrowers could save money if rates are low throughout the course of the loan. | Payments can fluctuate throughout the course of the financing term and interrupt the cash flow of the borrower. |
Rates offer more flexibility in terms of loan structure and financing options. | Total costs of financing can be more expensive over time if rates rise. |
Common Types of Financing for Fixed & Variable Rates
Both fixed and variable rates are commonly used for a wide variety of financing types. Depending on your financing needs and preferences, you can work with your provider to determine the best rate type for you. That being said, fixed interest vs variable interest should be factored into your budget, financing term, and funding amount.
Financing Commonly Associated With Each Rate | |
|---|---|
Fixed Rate | Variable Rate |
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When to Choose a Fixed vs Variable Rate
In some cases, you’ll be presented with both a fixed or variable rate option when applying for financing. This won’t always be the case, as some forms of financing may only have one option applicable, or perhaps the lender is only willing to pursue one option. In the event you are given a choice between the two rate types, see the use cases below to compare what each may be best suited for.
Factors to Consider When Choosing Between a Fixed or Variable Rate
If you’re in search of financing options and trying to determine whether or not you’d prefer a fixed or variable rate, you’ll need to consider your qualifications and preferred loan terms. In some cases, you may not have the option of both rate types, depending on the type of loan and your credit worthiness as a borrower.
When choosing between variable vs fixed rate loans, there are a few common factors to consider. These include:
- Determine your budget. You should consider if you can afford a fluctuating rate in the instance rates increase, or if it’s best you have a fixed payment to better manage your monthly payments and keep on top of your budget. Take a look at your current personal and business finances to make sure you can cover payments, regardless of the rate type you choose.
- Evaluate the risks. Research current market conditions and consider your risk tolerance. If rates are rising, it may be wise to enter into a fixed rate agreement to avoid further increases. If rates are favorably low, you could take advantage of a variable rate that has potential to decrease further.
- Review short- or long-term financing options. You’ll want to account for the amortization schedule of the loan, and whether or not your need for financing is short- or long-term. This is due to the fact that the longer the amortization period, the more you’ll be expected to repay overall.
- Compare the total costs of financing. If you’re presented with both fixed and variable rate options, it’s worthwhile to calculate and compare the total costs of financing. While you can’t always anticipate the final costs with a variable rate, try to determine what you can afford and how it’s applicable to the type of financing you need.
If you’re looking to get a business loan that offers both fixed and variable rate options, consider Lendio. It has a wide variety of small business loans to choose from with favorable rates and terms and can connect you, as a broker, with multiple providers with a single application.
Frequently Asked Questions (FAQs)
Variable rates can change at any given time in accordance with the benchmark rate index they’re associated with. The rate index can fluctuate based on market conditions and may increase or decrease upon review.
Yes. Most lenders offer options for loans with variable rate structures to later be converted into a fixed rate structure. Usually this comes with a fee and further documentation requirements necessary to make the switch.
It depends. In some cases, you may be subject to a prepayment penalty fee if the switch violates the terms of your financing agreement. There also may be other fees or documentation necessary, in which you should speak with your provider to walk you through the process and to ensure expectations are met.
Bottom line
The differences between fixed rates and variable rates can impact your need for financing based on market conditions, your risk tolerance and budget, and your preferences as a borrower. For borrowers who want to take advantage of favorable market rates and are comfortable with changing rates, a variable rate may be the best fit. For those wanting a more structured monthly payment without variance, a fixed rate is likely suitable. Be sure to consider these factors before making a decision and signing an agreement.
