Are you currently shopping for a credit card, mortgage, or any other type of loan? If so, one of the first questions to ask yourself is which type of annual percentage rate (APR) is right for you. You have two options: fixed or variable.
A loan with a fixed APR has an interest rate that typically stays the same throughout the life of the loan. However, it isn’t 100% guaranteed that your rate won’t change. There are certain circumstances that could cause a lender to adjust your rate.
A variable APR, on the other hand, will fluctuate with the market. As interest rates shift with market conditions, so will the APR on your loan. That, of course, can be either good or bad, making variable-rate loans the more risky option.
So what are the major differences between the two? And which APR is the right choice for you?
Is a fixed or variable interest rate better?
It may be tough deciding which type of APR is best for you. When taking out a loan, many people are torn between the security of fixed APRs and the potentially lower payments of variable APRs.
The right choice depends on your financial situation, the type of credit, and personal preference.
A variable APR offers the potential benefit of lower payments in the future – but not without its risks. You may end up with higher payments instead.
If interest rates are expected to rise, a variable-rate loan will often start lower than its fixed-rate counterpart. So if rates drop – or rise more slowly than expected – a variable-rate loan could end up costing less than a fixed-rate loan.
But if interest rates continue to rise, so will the cost of your variable-rate loan. If that’s the case, your variable APR could eventually surpass the fixed APR and wind up burning a deeper hole in your pocket at the end of the day.
While variable APRs often yield a lower overall cost, its “high risk/high reward” nature isn’t for everyone.
Here’s a general rule of thumb: a variable APR is primarily geared toward short-term loans and borrowers with a sizable cash flow.
A fixed APR offers more predictability and stability than a variable APR. However, the security of fixed APRs come at the expense of relatively higher interest rates.
But unlike a variable-rate loan, your payment amount won’t change. You’ll know exactly how much you owe each month, making it easier to properly budget. The downside is that you won’t be able to reap the benefits if APRs drop, as they sometimes do.
On the other hand, it isn’t always guaranteed that your APR won’t change. This is particularly true when it comes to credit cards.
A fixed-rate loan won’t suddenly change with every fluctuation of the market. But a credit card lender could change your rate if, for example:
- You’re late on your payments
- The period on your promotional rate has ended
- You’ve finished a debt management program
However, fixed APR loans typically never change. Credit cards are kind of an exception and only a few offer fixed APRs. In any case, they must notify you in advance before any changes go into effect. This will give you time to decide whether you want to:
- Keep the card with the new, increased rate
- Close the account and pay it off
- Transfer your balance to a new card
Analyze market trends
What does the market look like in terms of interest rates right now? This is an important question to ask yourself when trying to decide between a fixed or variable APR.
Paul Paquin, CEO of Golden Financial Services says, “Interest rates are sky-high in 2018. So, if you’re offered a high variable APR, and another bank offers you an equally high fixed rate APR loan, you may want to go with the variable rate. Rates are expected to eventually go down, and you don’t want to get stuck with the high rate.”
Finance and lending expert, Priyanka Prakash, thinks a fixed rate is wiser right now, “because the economy is expanding and market rates have been consistently rising for the last year or so. If rates decrease in the future, even if you have a fixed-rate loan now, you can take advantage by refinancing. That usually makes fixed APR loans the safer bet.”
Keep in mind that no one can accurately predict what the economy will do. Treat advice and trend predictions as an educated guess.
The beauty of refinancing
However, this isn’t an option for all loan types. So make sure you know what you’re getting yourself into before taking out a loan. Most credit cards, for instance, don’t permit refinancing. And student loans have tricky rules when it comes to refinancing.
Make sure you’re aware of the terms if you decide to refinance.
Whether you decide a fixed or variable APR is right for you, it’s imporhttps://www.supermoney.com/credit-cards-guide/tant that you understand all the details of the loan before signing on the dotted line. By doing so, you won’t be blindsided by hidden fees or a sudden rate change.