A variable interest rate loan is a loan in which the interest rate charged on the outstanding balance varies as market interest rates change. As a result, your payments will vary as well (as long as your payments are blended with principal and interest).
Fixed interest rate loans are loans in which the interest rate charged on the loan will remain fixed for that loan's entire term, no matter
what market interest rates
do. This
will result in your payments being the same over
the
entire term.
Whether a fixed-rate loan is better
for
you will depend on the interest rate environment when the loan is taken out and on the duration of the loan.
When a loan is
fixed for
its
entire term, it will be fixed at the then prevailing market interest rate, plus or
minus a spread that is unique to the borrower.
Generally speaking, if
interest rates are relatively low, but are about to increase,
then it will be better to lock in your
loan at that fixed rate. Depending on the terms
of your agreement, your interest rate on the new loan will remain fixed,
even if
interest rates climb to higher levels. On the other hand, if interest rates are on the decline, then it would be better to have a variable rate loan. As interest
rates
fall, so will the interest rate on your loan.
This discussion is
simplistic, but the explanation will not change in a more
complicated situation. It is important to note that studies have found that over time, the borrower is
likely to pay less interest overall with a variable rate loan
versus
a fixed rate loan. However, the borrower
must
consider the amortization
period of a loan. The longer the amortization period of a loan, the greater
the
impact a change in interest rates
will have on your
payments.
Therefore, adjustable-rate mortgages
are beneficial for a borrower in a decreasing
interest rate environment, but when interest rates
rise, then mortgage payments will rise sharply.