What is a fixed interest rate?

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In a Nutshell

A fixed interest rate is an interest rate that doesn’t go up or down with the prime rate or other index rate, so it generally stays the same. But that doesn’t mean your fixed rate can never change — a lender can change your fixed interest rate under certain circumstances.
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Having a fixed interest rate means that you’ll pay a set amount of interest on a loan or line of credit. Unlike a variable interest rate — which can go up or down in response to changes in the prime rate or other index rate — a fixed rate remains the same unless the lender changes it.

When you’re searching for a loan, you may see options with a fixed rate, or with a variable interest rate that can change over the life of your loan in step with the prime rate or other index rate. Knowing how a fixed rate works can help you decide which type of rate is the best choice for financing and repayment terms.

You may be able to get a fixed interest rate on various types of loans, including student loans, mortgage loans, auto loans, and home equity loans or home equity lines of credit.

However, you won’t find many credit cards with a fixed interest rate. Most revolving credit cards instead charge a variable interest rate.

Keep reading to learn how a fixed interest rate works and its pros and cons.

How does a fixed interest rate work?

With fixed-rate financing your loan’s interest rate won’t fluctuate over the life of the loan — meaning you’ll know exactly how much each monthly payment will be, as well as how much it will cost you overall to pay off the loan based on that rate.

On the other hand, a variable interest rate can fluctuate, lowering or raising the amount on your monthly payments accordingly. With a variable rate, you have no way of knowing when you take out the loan whether your payments will go up, down or remain the same over the life of the loan.

You won’t always have the option of choosing between fixed and variable. For example, federal student loans borrowed on or after July 1, 2006, have fixed interest rates. But private student loans may have either a fixed interest rate or a variable rate, the latter of which could change your payment amounts over time.

Can you switch from a variable to a fixed interest rate?

Depending on the lender and type of loan, you may be able to refinance your loan from a variable to a fixed interest rate, or vice versa. By refinancing from a variable rate to a fixed rate when interest rates are low, you can lock in a new, hopefully lower, interest rate.

Lenders must disclose whether the interest rate on a loan is fixed or variable, as well as what your interest rate will be, before you agree to the loan terms. If you’re not sure what your terms are for an existing loan, check your original loan documents or contact your bank or loan servicer.

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Pros and cons of a fixed interest rate

The benefit of a fixed-interest-rate loan is knowing that changing market conditions, or an increase in the prime rate or other index rate, won’t trigger a change in your fixed interest rate.

Of course, this works the other way, too. Even if the index rates go down and your lenders lower their variable rates, the interest on a fixed-rate loan will still stay the same.

It’s important to be aware, though, that a lender can change your fixed rate under certain circumstances — so you’ll want to read and understand the terms and conditions of your loan. In any case, your lender typically has to notify you in advance of any change in a fixed rate.

Is a fixed interest rate right for you?

Before you decide whether to go with a variable or fixed interest rate, let’s look at how each rate can affect your loan.

Let’s say you take out a 60-month $20,000 loan on a new car at a fixed interest rate of 3.99%, with monthly payments of about $368. Your total repayment amount with interest would be $22,094.

But if the loan has a variable rate, and the interest rate goes up, your payments and the total repayment amount could increase. Conversely, if the interest rate happens to drop, you may save money overall.

Choosing between a fixed or variable interest rate may come down to your comfort level with risk. While you may be able to find a variable-rate loan with lower initial interest rates than a fixed-rate option, you run the risk of the variable rate increasing before you’ve paid off your loan. If you like the security of a loan payment that won’t fluctuate according to the prime rate or other index rate, you may prefer a fixed interest rate.

Bottom line

Before you sign any loan documents, make sure you know whether you’re getting a fixed interest rate or a variable rate. If you’re comfortable with the unknown and some risk, you may opt for a variable rate. But if you want your monthly payment, as well as how much you’ll pay over the life of the loan, to be more stable, a fixed rate may be a better choice for you.

About the author: Deb Hipp is a freelance writer with a bachelor’s degree in English and creative writing from the University of Missouri-Kansas City. When she’s not writing about personal finance and news, she enjoys traveling to seas… Read more.