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 loan will remain fixed for that loan’s entire term, no matter what market interest rates do. As a result, your payments remain the same over the entire term.
When a loan is fixed for its entire term, it remains 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, it could potentially 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 stay the same, even if interest rates climb to higher levels. On the other hand, if interest rates are on the decline, then it could be better to have a variable rate loan. As interest rates fall, so will the interest rate on your loan.
We are seeing variable rates being lowered due to slowing mortgage growth.
Fixed Interest Rate or Variable Rate Loan?
This discussion is about comfort level, and flexibility to adjust to the changes in the economic market. The borrower must consider the amortization period of a loan as well. The longer the amortization period of a loan, the greater the impact a change in interest rates will have on your payments.
Adjustable-rate mortgages (ARM) are beneficial for a borrower in a decreasing interest rate environment, but when interest rates rise, then mortgage payments will rise sharply.
A good way to mitigate this is to take a Variable rate mortgage but set your payments higher than the minimum payment required. For example, Prime; Right now, prime is at 3.45%, but you can get a 5-year ARM at prime -1.09% (2.39%). If you were to take the ARM but set your payments at prime, you would be making 1.09% more in payments to your mortgage principle on day one. If prime were to rise or fall your payments would stay at 3.45%; you would just be making more or less extra payments against your mortgage principle. The only way your payments would change is if you chose to change them, or the Prime rate goes above 3.45+1.09% (prime rate would have to go to 4.54% for your payments to go up.)