Fixed vs. Floating Interest Rates

When you take out a loan, the interest you are charged typically comes in one of two forms: fixed or floating. Each has its benefits and drawbacks, and any consumer contemplating a loan should know the different between the two to make an informed decision about your loan and how it will affect you.

Fixed Interest Rates

A fixed interest rate is one that remains the same over the length of the loan's term. Fixed rate loans come in a variety of forms, including mortgages, car loans, personal loans and even credit cards. However, interest rates on some fixed-rate loans, such as credit cards, can change. If, for example, you take out a credit card and fail to make your payments for several moths, the credit card company can increase your fixed rate

Floating Rate

Floating rate loans, also known as variable-rate or adjustable-rate loans, have interest rates that change over time. The conditions under which the loans change differ depending on the terms of the loan, but, in general, the interest rates on these loans are tied to indexes. An index, such as the London Interbank Offered Rate, or LIBOR, are industry-wide measurements of average interest rates offered by lending institutions. When these interest rates change, so does the rate charged to borrowers of a floating rate loan.

Fixed Rate Pros and Cons

The primary advantage of a fixed rate loan is the borrower's ability to secure a particular interest rate at a particular time. When, for example, interest rates are low, borrowers often seek out fixed interest rate loans as a hedge against future rate hikes. If you take out a fixed-rate mortgage when interest rates are low, you won't have to make higher interest payments if interest rates later go up. However, if interest rates go lower, you generally cannot take advantage of this unless you refinance your loan.

Floating Rate Pros and Cons

A floating rate loan's primary advantage is that lenders generally charge lower initial interest rates to borrowers than they do for fixed-rate loans. A fixed-rate loan has the advantage of not being tied to a permanent loan rate. If, for example, you take out a variable-rate loan when rates are high, your interest will decrease if rates later go down. A fixed-rate loan taken out at the same time would not. The primary downside of a variable rate loan is that you may have to make far different payment amounts during the life of the loan.