There are two main types of loan and they are a fixed rate loan and a variable rate loan. It is important to understand what the difference is between them so that you can work out whether one or the other is better for you and your needs.
What is a fixed rate loan?
A fixed rate loan will have a fixed rate of interest either for the whole loan term or for a certain part of a loan. For example, a fixed rate mortgage will generally only have the fixed rate for three to five years and then will move onto a variable rate, whereas a payday loan such as those offered by Emu will have a fixed rate for the who loan period which is likely to just be a few weeks.
If you feel that the interest rate is likely to rise during the fixed rate term, then taking a loan like this will protect you form this rate rise. However, a fixed rate tends to start out dearer than a variable rate so if rates do not go up you could end up paying more. A fixed rate will also not go down if the base rate drops, whereas a variable rate might drop. Some people do like the fact that with a fixed rate they will know exactly how much they will have to repay each month and if they are short of money, then this could mean that they do not take on the risk that their repayments might go up.
What is a variable rate loan?
A variable rate loan will vary in interest. The lender will be able to put the interest rate up and down when they wish. Often this will be in response to a change in the base rate, however, they are more likely to put a rate up when the base rate rises than they are to put it down if the base rate falls. Some variable rate loans are set up as a tracker which means they will track the base rate and this will mean they have to go down when the rate falls, but they will also always go up when it rises but they should not change at any other time (but this will depend on the way that the loan is set up). Some lenders will change the rates in between base rates changes as well, especially if the rate has not gone up for a long time.
Some people like the fact that the rate can go down and therefore if they choose a variable rate they will not be stuck into a higher one.
Which is best?
It is also worth noting that many fixed rate loans will tie you in to their loan. This means that if you want to swap to a cheaper lender or even change loans with the same lender then you will not be able to do this without pay a fee. These fees can be quite small but sometimes they can be very high. It is worth finding out if there is a fee and how much it will be so that you are prepared for this when you sign up for the loan.
As you can see it can be quite tricky deciding which loan type to get. If you feel that you may struggle with repayments if they go up any higher then fixing can protect you against rate changes and mean that you will be more likely to be able to make all of your repayments on time. If you are confident that you will be able to make the repayments, then it is wise to calculate how much they might go up if rates rise. You will then have an idea of whether you will still be able to pay these amounts of money and this will help you to know whether you will be able to afford a variable rate.
It can be hard to predict the future, even in the short term. It is therefore very hard to know whether rates might rise or fall and whether your capability of making repayments will change as well. However, if you have a stable job in a company that is doing well then you should have more confidence compared with someone that has a temporary job or is working for a struggling company. Also, with rates, if they are high, then they are more likely to fall than rise but if they are low, they may go up. However, this is more speculation than prediction and so it is good to be prepared for the worst, just in case. You can protect yourself against rate changes by having some savings behind you which will help you to afford a higher amount of necessary or have a plan on how you would reduce spending or earn more should you need to.