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Fixed Interest Rate Loan

Definition

A fixed interest rate loan is a loan where the interest rate doesn't fluctuate during the fixed rate period of the loan. This allows the borrower to accurately predict their future payments. Variable rate loans, by contrast, are anchored to the prevailing discount rate.

A fixed interest rate loan is a loan in which the interest rate doesn't fluctuate during the fixed rate period of the loan. This allows the borrower to accurately predict their future payments. The borrower will pay a set amount of interest on a loan or line of credit. Unlike a variable interest rate loan, in which the interest rate can go up or down in response to changes in the prime rate or other index rate, a fixed rate remains the same unless the lender changes it. A fixed interest rate is based on the lender's assumptions about the average discount rate over the fixed rate period. For example, when the discount rate is historically low, fixed rates are normally higher than variable rates because interest rates are more likely to rise during the fixed rate period. Conversely, when interest rates are historically high, lenders normally offer a discount to borrowers to fix their interest rate over time, as rates are more likely to fall during the fixed rate period.

How Does a Fixed Interest Rate Work?

With a fixed rate loan, you’ll know exactly how much each monthly payment will be, as well as how much it will cost you overall to pay off the loan based on the agreed upon rate. On the flipside, a variable interest rate loan can fluctuate; meaning you’ll have no way of knowing if/when your payments will go up, down, or remain the same during the life of the loan. Borrowers do not always have the option of choosing between fixed and variable rate loans. Lenders must disclose where the interest rate on a loan is fixed or variable, as well as what the interest rate will be, prior to agreeing to the loan terms.

Can I switch from a variable to a fixed interest rate?

Depending on the lender, and the type of loan, you may be able to refinance your loan from a variable interest rate to a fixed interest rate (or vice versa). By refinancing from a variable interest rate loan to a fixed interest rate, especially when rates are low, you can lock in a new, hopefully lower, interest rate for the remainder of the loan terms.

Pros and Cons of a Fixed Interest Rate

The benefit of a fixed interest rate loan in the security of knowing that the changing marketing conditions, an increase in the prime rate or other index rate, won't trigger a change in your fixed interest rate. The negative of the above, is that the opposite rings true. Even if index rates go way down, and your lenders lower their variable rates, the interest on a fixed-rate loan will stay the same. Choosing between a fixed interest rate and a variable interest rate comes down to your comfort level with risk. If you like the security of a loan payment plan that will not change over the length of the loan, go with a fixed interest rate.

Further Reading


Choosing between fixed and adjustable rate mortgages: Note www.jstor.org [PDF] … an adjustable rate mortgage if they can qualify for a much larger loan instead … change the values of the reported coefficients except for the coefficient on the fixed interest rate. A potential specification bias arises because marginal tax rates have important economic effects on the …
The market for interest rate swapsThe market for interest rate swaps www.jstor.org [PDF] … an adjustable rate mortgage if they can qualify for a much larger loan instead … change the values of the reported coefficients except for the coefficient on the fixed interest rate. A potential specification bias arises because marginal tax rates have important economic effects on the …
Fixed rate loan commitments, take-down risk, and the dynamics of hedging with futuresFixed rate loan commitments, take-down risk, and the dynamics of hedging with futures www.jstor.org [PDF] … an adjustable rate mortgage if they can qualify for a much larger loan instead … change the values of the reported coefficients except for the coefficient on the fixed interest rate. A potential specification bias arises because marginal tax rates have important economic effects on the …
A note on equivalent fixed rate and variable rate loans; borrower's perspectiveA note on equivalent fixed rate and variable rate loans; borrower's perspective www.tandfonline.com [PDF] … an adjustable rate mortgage if they can qualify for a much larger loan instead … change the values of the reported coefficients except for the coefficient on the fixed interest rate. A potential specification bias arises because marginal tax rates have important economic effects on the …
Hedging and financial fragility in fixed exchange rate regimesHedging and financial fragility in fixed exchange rate regimes www.sciencedirect.com [PDF] … an adjustable rate mortgage if they can qualify for a much larger loan instead … change the values of the reported coefficients except for the coefficient on the fixed interest rate. A potential specification bias arises because marginal tax rates have important economic effects on the …
How and why do small firms manage interest rate risk?How and why do small firms manage interest rate risk? www.sciencedirect.com [PDF] … an adjustable rate mortgage if they can qualify for a much larger loan instead … change the values of the reported coefficients except for the coefficient on the fixed interest rate. A potential specification bias arises because marginal tax rates have important economic effects on the …
The reversal interest rateThe reversal interest rate www.nber.org [PDF] … an adjustable rate mortgage if they can qualify for a much larger loan instead … change the values of the reported coefficients except for the coefficient on the fixed interest rate. A potential specification bias arises because marginal tax rates have important economic effects on the …
Fee-based pricing of fixed rate bank loan commitmentsFee-based pricing of fixed rate bank loan commitments www.jstor.org [PDF] … an adjustable rate mortgage if they can qualify for a much larger loan instead … change the values of the reported coefficients except for the coefficient on the fixed interest rate. A potential specification bias arises because marginal tax rates have important economic effects on the …
The borrower's choice between fixed and adjustable rate loan contractsThe borrower's choice between fixed and adjustable rate loan contracts onlinelibrary.wiley.com [PDF] … an adjustable rate mortgage if they can qualify for a much larger loan instead … change the values of the reported coefficients except for the coefficient on the fixed interest rate. A potential specification bias arises because marginal tax rates have important economic effects on the …


FAQ


What does a fixed rate loan mean?

A fixed interest rate is a constant rate charged on a liability, such as a loan or mortgage. It might apply throughout the loan's entire term or just part of the term, but it remains the same throughout a set period.

Is a fixed rate loan better?

Fixed student loan interest rates are generally a better option than variable rates. The reason is fixed rates are constant, while variable rates can change monthly or quarterly in response to economic conditions. If you're unsure which rate to choose, go with fixed; it's safer.

When should you consider an adjustable rate mortgage?

An ARM with a lower initial rate could be a better (and cheaper) way to go. The benefits of getting an adjustable rate mortgage are enhanced when you want to live in a property for a short period(1-10 years). You can enjoy the interest and payment benefits with less of the risk.

Why is an adjustable rate mortgage bad idea?

Rising interest rates means you're taking all the risk. With an ARM loan, after just a couple of rate resets, your initial interest-rate savings could vanish.

What are the benefits of an adjustable rate mortgage?

Feature lower rate and payment early in the loan term. Borrowers can take advantage of falling rates without refinancing. Help borrowers save and invest more money. It's a cheaper way for borrowers not planning to live in a place for very long to buy a house.

How often does an adjustable rate mortgage adjust?

A typical ARM adjusts once a year. However, there are also ARMs that adjust every six months or after longer intervals, such as two-year ARMs. You can find some other types of ARMs that don't adjust at the same, fixed interval, but they have more creative patterns.

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