Is a Personal Loan Variable or Fixed Rate? Everything You Need to Know

Personal loans can be an affordable way to pay for expenses like medical bills, home repairs, or other major costs. But before taking out a personal loan, it’s important to understand how interest rates work. Specifically, you’ll want to know if personal loans have variable or fixed interest rates.

In this comprehensive guide, we’ll explain the key differences between variable and fixed interest rates. We’ll also provide tips to help you decide if a variable or fixed rate personal loan is the right choice for your financial situation.

An Overview of Variable vs Fixed Interest Rates

First, let’s go over the basics

A variable interest rate means the rate you pay can go up or down over the loan term. Variable rates are tied to an external benchmark like the prime rate. When that benchmark rate changes, your variable interest rate will also change.

With a fixed interest rate, your rate stays the same for the entire loan term. This allows you to lock in an interest rate when rates are low. Even if market rates increase later, your fixed rate won’t change.

Lenders offer both fixed and variable rates on personal loans. But the majority of personal loans have fixed rates. This provides predictable payments borrowers can easily budget for.

Now let’s take a closer look at how variable and fixed rates impact your loan.

How Do Variable Interest Rates Work?

As mentioned above, variable interest rates can fluctuate over the loan term. With a variable rate personal loan, your rate is tied to an index like the prime rate.

Here’s an example to show how this works:

Let’s say the prime rate is 5% when you take out a $10,000 personal loan with a 10% variable interest rate. Since your rate is variable, it’s calculated as the prime rate (5%) plus a margin of 5% set by the lender. So your initial rate would be 10%.

If the prime rate later increases to 6%, your new variable rate would become 11% (the new prime rate of 6% plus your margin of 5%). So your monthly payment would increase to account for the higher interest charge.

The main benefits of a variable rate personal loan are:

• Your rate can go down. If the benchmark index decreases, your interest rate will also decrease. This can save you money on interest.

• Lower initial rate. Variable rates often start lower than fixed rates. But keep in mind they can increase over time.

The cons of variable rate loans include:

• Unpredictable payments. Since your monthly payment changes as your rate changes, it can be hard to budget.

• Risk of rate hikes. Variable rates could end up costing you more in interest if rates trend higher.

How Do Fixed Interest Rates Work?

With a fixed rate personal loan, the interest rate stays the same for the entire loan term. Your lender will set your rate based on factors like your credit score and income when your loan originates.

Here’s an example:

Let’s say you qualify for a $10,000 personal loan with a 10% fixed interest rate. If the term is 3 years, your monthly principal and interest payment will be $311.

Even if market rates increase or decrease over those 3 years, your fixed 10% rate will stay the same. This results in predictable payments that won’t change.

The main advantages of fixed rate personal loans are:

• Predictable payments. You’ll know exactly what your payment will be each month.

• Fixed rates may have longer terms. Some lenders offer fixed rate loans with 3 to 5 year terms.

• May protect you from rate hikes. Your rate won’t increase if market rates trend higher.

Potential cons include:

• Your rate won’t decrease. You won’t benefit if market rates fall lower than your fixed rate.

• Higher rates for lower credit scores. Fixed rates are often higher for borrowers with poor credit.

Are Personal Loans Usually Variable or Fixed?

The majority of personal loans have fixed interest rates, especially those from online lenders and credit unions.

Banks are more likely to offer personal loans with variable rates tied to the prime rate. But fixed rates are still more common.

According to research from the Federal Reserve, around 75% of unsecured personal loans issued by commercial banks have fixed rates. The remaining 25% have variable rates.

Online lenders and credit unions issue an even higher percentage of fixed rate personal loans.

This widespread use of fixed rates provides stability for borrowers. But banks may prefer variable rate personal loans because it helps protect them against interest rate fluctuations.

In general, both fixed and variable rate personal loans serve unique needs. So it’s good to have both options available.

Should You Get a Variable or Fixed Rate Personal Loan?

Deciding between a fixed vs variable rate personal loan depends on your financial situation and goals.

Here are some key factors to consider:

Loan term. Fixed rates are common for longer 3-5 year personal loan terms. But a variable rate could make more sense for a shorter 1-2 year loan.

Market rate forecast. Compare current rates to historical averages. If rates are low, locking in a fixed rate personal loan could save you money long-term.

Your budget. Fixed rate loans provide consistent payments that are easier to budget for. But variable rates may start lower.

Credit health. Borrowers with lower credit tend to get higher fixed rates. A variable rate could mean a lower initial payment.

Interest rate caps. Variable rate personal loans often come with interest rate caps that limit rate hikes. Ask the lender before borrowing.

Be sure to compare interest rates and fees quoted by multiple lenders as well. This can help you find the best personal loan for your situation.

Tips for Getting a Low Rate on a Personal Loan

These tips can help you qualify for the lowest rate possible, whether you choose a fixed or variable personal loan:

• Compare rates from multiple lenders to find the best deal. Online lenders often offer more competitive rates than banks.

• Check your credit and dispute any errors on your credit reports before applying. Improving your score can help you earn a lower rate.

• Reduce credit card balances. High credit card balances compared to limits can negatively impact your rate. Pay down balances before applying.

• Provide paystubs or tax returns to verify your income when applying. Higher income often means a lower rate.

• Choose a shorter term. You’ll pay less interest over time with a 12 or 24 month personal loan vs. a 60 month loan.

• Bring a co-signer. Adding a co-signer with good credit can help you qualify for the lowest advertised rate.

• Weigh pros and cons of fixed vs variable. Compare both options and understand how your rate could change under each scenario.

Is Now a Good Time for a Personal Loan?

In general, personal loan rates are near all-time lows as of early 2023. However, the Federal Reserve has been steadily raising benchmark rates over the past year.

This means borrowers may want to consider locking in fixed personal loan rates now before additional rate hikes potentially occur. Rates ticked up slightly at the end of 2022 but are still very competitive.

For borrowers with good credit, fixed rates for a 2-year personal loan currently range from about 5% to 12% APR. Average rates for 5-year loans range from about 6% to 15%.

But again, shopping around and comparing personal loan offers is the best way to find the current lowest rate.

The Bottom Line

Personal loans provide an accessible way to borrow for many purposes. And knowing whether personal loans have variable or fixed interest rates can help you optimize the cost of borrowing.

In most cases, expect personal loans to have fixed interest rates that provide predictable payments for the loan term. This allows you to budget and manage repayment.

But evaluat`e your specific needs, credit score, loan purpose, and the rate environment to decide if a variable or fixed rate personal loan is the right financial move.