Many people like the security of choosing a fixed rate loan. However, there are others that choose to avoid them. It is worth understanding what a fixed rate loan is so that you can decide whether it will be in your advantage to consider taking one out.
What Is a fixed rate loan?
A fixed rate loan is one where the rate of interest is fixed for a certain period. For some loans it could be fixed for the whole time, but most commonly it is fixed just for a certain period of time. These are most often mortgages, where the first few years could be on a fixed rate which then switch to a variable rate after this time. Borrowers will often have a choice between a fixed or variable rate in the case of a mortgage and so it is important to understand what the advantages and disadvantages of each are.
With a fixed rate loan you will know exactly what interest you will be paying for the fixed rate period. This means that you will not have to worry at all about interest rates rising and what impact this might have on you. So, if you are worried that rates might go up, then this could be a good option to protect you from those rate rises. However, it is worth noting that it is really hard to predict whether rates might go up or down. If You feel that you will only just manage the repayments, then you may not be able to afford them if the rates go up and so this can protect you against this as well.
It may seem that a fixed rate loan is really good, but there are some disadvantages too. Firstly, if the variable rates go down, then you will not be able to take advantage because you will be tied into a fixed rate. Even if the variable rates stay the same, you may still be paying more than you would have done with a variable rate as the fixed rates are often higher. Another possible problem is that you will often be tied in to a fixed rate. This means that you will not be able to move to another lender if the rates become uncompetitive. So, if rates fall just as you start a five-year fixed rate deal, you could find that you will be paying a lot higher than necessary for a long time before you can switch lenders. If you are tied in there will be a way out but it will be costly. You will have to pay a fee and this could be very much more than you will save in interest by switching to another lender and so it is unlikely to be worth doing, but always worth looking at just in case.
Is it right for me?
It can therefore be difficult to know which option to choose. As it is very difficult to predict interest rate changes, then trying to guess whether they will go up or down is not wise. However, it is worth assuming they might go up and calculating whether you could afford the repayments if this is the case. If you think that you will struggle, then the safe thing to do is to take a fixed rate so that you can then guarantee that you will not have to pay more. Compare lenders though as their fixed rates will vary and some may not tie you in or may not charge you so much if you do want to swap lenders during the fixed rate period.
However, if you can manage the repayments easily and could still cope if rates went up then you might rather take a variable rate. You will always have the option of switching to another lender and fixing should you change your mind. You will, of course, risk having to repay more if rates do go up but you will also be able to pay less should rates fall. That is assuming that your lender puts down their rates of course. If the Bank of England base rate goes down, not all lenders will reduce their rate. However, you will not be tied in so you could switch to one that has come down or you could take out a tracker. A tracker will track the base rate and this means that when it falls, you will immediately start to pay less interest. However, if it goes up, you will immediately start paying more. However, most lenders will put their rates up almost immediately if the base rate rises anyway. You will need to decide what sort of risk you are willing to take and which loan type is most likely to suit your lifestyle and finances.