When borrowing money, it is important to know what type of interest rate you have. For example, on mortgages, it is possible to choose between fixing interest rates and having them floating. For other types of loans, it is common for the interest rate to be either fixed or variable and you have nothing to say about. Regardless, it is important to know what the difference is between the different types.
What is the variable interest rate?
The short answer to this is that a variable interest rate is a rate that is constantly changing. Depending on how the economy is largely going, interest rates will either go up or down. This compares with a fixed interest rate that will always remain at the same level, regardless of what happens during the bond period.
Then it should be said that variable interest rates are not completely variable either. If you look at mortgages, what is called variable interest is actually an interest rate that is fixed for 3 months. Thus, it is only every three months that the interest rate will change.
Advantages and disadvantages of variable interest rates
If you look at it from a historical perspective, it has been cheaper with a variable interest rate than a fixed one. Then there is no guarantee that this is always the case. For example, if interest rates have been at a very low level, it may be more economical to tie up the interest rate for a number of years in the future than to keep it variable. After all, it’s hard to say what will happen in 5 years or so. But if you look back in time, it is cheaper with variable interest rates.
However, what you do not get with a floating interest rate that a fixed rate provides is security. It is safer to know that you will have to pay X amount of interest each month for your loans. For a bonded loan, you know exactly what to pay during the entire term, which does not apply at all to floating loans. This means that it is often a good idea to have parts of the loan tied up if you do not have large margins in the economy. If you instead have quite a lot of money each month, it may very well be worth taking a little more risk and in this way probably save money.
One advantage that you do not always think about with variable loans is that they are easier to solve. All loans can always be redeemed prematurely if you wish, but a tied loan risks costing to pay off. Flexible loans can always be redeemed at no extra cost.