Which Interest Rate Should You Choose?

How to Choose the Right Interest Rate

Let me start out by saying there is no right decision when it comes to choosing an interest rate. Like most things in the financial world, the decision will depend on your individual situation. There are no hard and fast rules dictating what type of interest rate, fixed or variable, will be the best in all cases, so it’s important for you to weigh your options given your current circumstances. If you need some time to pay off your loan, perhaps a fixed interest rate is the smarter choice. If you want to pay off your debt as quickly as possible, a variable rate may be the best decision. Regardless of what types of loans you currently have or are planning to apply for in the future, it is important to acquaint yourself with the differences between fixed and variable interest rates in order to make an informed decision. Choosing the best rate for your particular financial situation will allow you to more easily afford your monthly loan payments and prevent monetary strain.

Since there is no definitive answer when it comes to which type of interest rate is best, it is helpful to consider the pros and cons of each option. Once you know what each type of interest rate entails, you will be able to more clearly determine which rate is best for you. As is the case with all matters in the financial realm, it is vital for you to arm yourself with as much knowledge as possible. As they say, knowledge is power, so you want to be sure you know all the relevant facts before taking out a new loan or refinancing one or more existing loans. If you are interested in refinancing, doing so can help you get a lower interest rate, as well as consolidate all your loans into one place for ease of payment. For example, if you have several student loans, you can refinance them and only make one comprehensive payment per month. If you are interested in refinancing student loans, or any type of loan for that matter, keep in mind you will need a solid credit score and all loans in good standing in order to get the best interest rate available.

Fixed Interest Rate

Like most things in life, there are pros and cons to both fixed and variable interest rates. First, let’s explore fixed interest rates. Not surprisingly, fixed interest rates offer one steady rate over the life of the loan. You don’t need to worry about a spike in interest or feeling pressure to quickly pay down the debt before the rate increases. Refinancing with a fixed rate gives you a sense of stability. If you have a large amount of debt and it will take you years to pay off, a fixed interest rate may be right for you. Since your interest rate will not change, you can account for the payment in an emergency fund in case you lose your job or your income decreases. On the other hand, a fixed interest rate will be higher than a variable rate and it can take longer to pay off the loan because the APR starts higher than with a variable rate.

Variable Interest Rate

As the name suggests, variable interest rates are subject to change. Unless you pay off your loan at a quick pace, the rate is almost guaranteed to change. Most lenders base their interest rates on the LIBOR rate (London Interbank Offered Rate) — a benchmark rate for banks around the world. If the LIBOR rate is low, variable interest rates will be low, and vice versa. Be sure to ask a lender if the variable rate can increase from month-to-month or if it is locked in for a set period of time before it increases. Variable rates have a cap, but it will be quite a bit higher than a fixed rate, so be sure you know the cap before agreeing to any terms.

If you are confident in your ability to repay the loan quickly, a variable rate is ideal. Typically, the loan is relatively low and you are not worried about taking care of other major expenses during the repayment period. Variable rates allow for aggressive payments before the rate hike and initial rates are currently low, but the rate could increase from month-to-month. Plus, the cap on a variable rate is often higher than a fixed rate offer. The variability of the offer makes it difficult to know how much you need to sock away in an emergency fund in the case of a job loss or decrease in income.

There are ideal qualities in any loan — whether you choose a fixed or variable interest rate. Be sure to do your homework in order to know which choice is best for you and be aware of possible scams. Work with lenders who do not offer origination fees or prepayment penalties. If you need a co-signer, work with someone who offers a co-signer release.