Should I get a fixed or variable personal loan?

There are many factors that go into selecting a personal loan, such as deciding on a lender and comparing the different features of loans. One of the most important concerns is deciding between a fixed or variable interest rate.

Depending on the lender and the specifics of the loan, you may be able to choose between a fixed and a variable rate. However, there are a few distinct differences between the two, so it’s important to weigh up your options before determining which type of personal loan is right for you.

Fixed rate personal loans

In simple terms, a fixed interest rate does not change.

A fixed interest rate personal loan offers borrowers a sense of financial security - the amount you’ll need to repay won’t change over the course of the loan’s term. You’ll be sheltered from any future rate rises.

However, you’ll miss out on possible rate reductions.

Lenders generally don’t allow lump sum or additional payments to settle fixed rate loans early. If there are such opportunities, you’ll often have to pay a fee or penalty. These extra costs may negate any potential savings.

Pros:

• Protected from interest rate rises
• Makes budgeting easier as you’re aware of the total costs upfront

Cons:

• Minimal flexibility on loan conditions
• Additional fees for breaking repayment costs
• Don’t benefit from interest rate reductions

Variable rate personal loans

A variable interest rate is subject to fluctuations. Lenders set their interest rates based on a wide range of factors. One of the primary influences is the official cash rate set by the Reserve Bank of Australia (RBA) - when the cash rate rises or falls following each monthly RBA meeting, variable rates tend to vary accordingly.

Don’t count on securing a personal loan at the cash rate determined by the RBA. This rate is what the banks must pay when they borrow money, therefore the rates they charge customers will be different.

Some lenders also choose to raise or lower their interest rates out of cycle with the RBA, possibly in relation to other economic factors, such as funding costs, risk and competition.

If a lender raises its interest rates, borrowers can expect their repayment costs to increase. Similarly, if a lender cuts interest rates, a borrower may benefit from lower repayments.

The potential disadvantage of a loan with variable interest is that repayment amounts are less predictable.

Variable rate personal loans generally offer more flexibility than fixed interest loans. For example, you may be able to procure lengthier repayment terms, as well as the option of paying off the loan early. Unlike fixed loans, you typically won’t be charged fees for extra repayments or lump sum settlements.

Some lenders may allow borrowers to redraw additional funds they’ve paid on their loan. Be aware that there could be limitations imposed on the amount you can withdraw and doing so may incur additional fees.

Pros:

• Greater flexibility
• Typically less fees/costs for extra repayments
• Benefit from interest rate reductions

Cons:

• Subject to interest rate rises

Which is better - fixed or variable personal loans?

As is the case with most financial decisions, the loan that’s right for some borrowers may not be right for you.

Keep in mind that there is more to a personal loan than the interest rate you’ll pay. Other considerations include fees, features, repayment schedule and any benefits offered by lenders.

Your credit score can assist lenders in determining whether or not you’re an equitable borrower. Learning and improving your credit score could assist in negotiating better financing.

It’s important to compare the market and conduct extensive research. Consider your financial situation and budgetary requirements. Deciding on the amount you’ll need to borrow and how long it will take you to repay the loan, plus interest, is also relevant.

A helpful way to compare personal loans is to use RateCity’s Real Time Ratings™. Loans are ranked based on individual requirements, with a score out of five based on loan costs and flexibility. It takes into consideration your ideal loan size, loan term, borrowing purpose and if you’re securing the loan, to give you a tailor-made result.

If you’re still not certain whether a variable or fixed rate personal loan may best suit your individual needs, you might consider contacting a financial advisor and discussing the different options available.

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