Suppose you have $29,000 in student loans and you apply for a consolidation loan with the bank. Once the credit was approved, the bank gives you the choice of 8% Annual Percentage Rate (APR) with a fixed rate or 6% APR with a variable rate. Which would you choose?
At first glance, the 6% annual percentage rate looks like the more attractive option because of its lower rate. However, this is variable, which means the APR can increase over time, resulting in a higher monthly payment. This could catch you by surprise if you have not prepared for it. I would recommend the fixed 8% rate since it gives you certainty when planning your finances in the future. You might question why I would recommend paying the higher rate, especially when paying 6% is more appealing than paying 8%. Assuming that there is no cap on your variable interest rate, it is a reasonable assumption that your APR could increase to 10% or higher, and you will end up paying more.
In a related fixed vs. variable rate situation, many homeowners in the past have been caught out by these Adjustable Rate Mortgages (ARM). These loans had lower interest rates than the prevailing fixed rates at the time. As a result, these ARMs made the payments more affordable at the beginning of their terms. However, the party ended when interest rates increased, and many of these homeowners were left unable to pay their mortgages. The moral of the story is that without predicting the future movements of interest rates, it is a safer bet to take the fixed rate over an adjustable one.
What would you do in this situation? Which is better? Fixed or Variable rates?
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