Which is Better a Fixed or Variable Rate?
When you are looking at either borrowing money or saving money, you will often find that the interest can be fixed or variable. You may wonder what the difference is between these and which you should consider using yourself.
What are fixed and variable rates?
A fixed rate is when the interest rate on a product remains that same. This could for the whole time that you have a particular product or it could be for a certain time. For example, a fixed rate bond is a savings account when the rate will be fixed for the whole time the bond lasts which is likely to be a number of years. However, a fixed rate mortgage is likely to only have a fixed rate for a number of years and as a mortgage will tend to last for decades then this will be just a short percentage of the time.
A variable rate can be changed at any time. This means that the provider can choose when to put the rate up and down. They will often do this in response to changes in the base rate made by the Bank of England but they might choose to do it at other times as well. This means that you will need to keep a check on the rates so that you are aware of what they are and will know whether you need to consider switching.
When is it Better to use Fixed?
Often with a fixed rate you will be tied in. For example, with a fixed rate bond you will need to keep your savings in the bond for the whole time that it runs for in order to get all of the interest. This could be for a year or possibly up to five years. This means that you will have to be prepared to not be able to spend that money for that period of time. This could be something that will suit some people and not others and it is worth having a think about whether you will be happy to tie your money up for this time or whether you might need it. So if you are happy tying the money up then it could be good to go for this fixed rate.
With a mortgage it can be similar in that you can also be tied in for the fixed rate period and possibly beyond. This will often mean that you will have a very large amount to pay by way of a charge if you do want to move. If the interest rates go down significantly, then you will find that you could end up with a very expensive mortgage that you cannot get out of. However, if the rates go up, you will be protected against those rate rises. You have to be a bit of a fortune teller and think about what might happen in the future before deciding whether this will be right for you.
A final advantage of a fixed rate mortgage is the fact that you will know exactly how much you will be paying each month. This can be extremely useful as you will not have to worry about where you would find the extra money, should the rate suddenly rise. A lot of first time buyers will use this as they are likely to be very stretched already with the cost of the mortgage and find that they would not be able to afford to pay any extra in to the mortgage and so knowing that the amount will not change can be really good.
When is it Better to use Variable?
If you think that the interest rate is likely to change then it could be worth using a variable rate in some circumstances. So, if you think that it is going to fall then having a variable rate on a mortgage can be good as your rate could go down. However, if you have savings, then you will not want the interest you are getting to do down. Of course the opposite also is the case where if you expect rates to go up then you may not want a fixed rate on your savings and hope that the rate will go up on those but you may want to fix the rate on your mortgage so you do not end up paying more.