What Is Fixed Interest Rate? Explanation And Its Advantages/Disadvantages

What is a fixed interest rate (Image: Andre Taissin - Unsplash)

YOGYAKARTA - Have you ever heard of fixed interest rates? Then what is a fixed interest rate?

What is a Fixed Interest Rate

A fixed rate is an interest rate that doesn't change over the term of your loan, or at least for a certain amount of time.

The Bank of England regularly applies fixed rates for mortgages and savings accounts.

For example, a bank will offer a fixed 5 percent interest rate on your savings for one year, which then drops to 1 percent or less.

In many cases, this interest isn't paid until the account matures, so it's basically a "golden cuff" that ensures you stay a customer for at least a year.

Interest Rate Illustration (Konstantin Evdokimov - Unsplash)

How do fixed rate loans work?

A fixed rate loan means that you only have to pay an agreed amount of interest for a certain period of time – for example, one year.

The opposite of this is variable credit. The following types of loans can all come with fixed rate offers:

• student loans
• Mortgage
• Car loan
• Home equity loans
• Credit card

With fixed interest rates, interest is added to the amount you borrow (known as the principal amount).

Each payment includes both the interest accrued and a portion of the principal payment.

For credit, fixed interest can help control the extra fees that come with late payments, although you shouldn't enter into a credit agreement if late payments are likely to be a regular occurrence.

Banks and lenders are required to tell you what kind of rate you are signing up for. Be aware that banks can change interest rates at any time, but this should also be described in small print.

You may also be given a breakdown of your payments over a certain period of time, so you can see how much you will be paying each month.

• Mortgage
• Car loan
• Home equity loans
• Credit card

With fixed interest rates, interest is added to the amount you borrow (known as the principal amount).

Each payment includes both the interest accrued and a portion of the principal payment.

For credit, fixed interest can help control the extra fees that come with late payments, although you shouldn't enter into a credit agreement if late payments are likely to be a regular occurrence.

Banks and lenders are required to tell you what kind of rate you are signing up for. Be aware that banks can change interest rates at any time, but this should also be described in small print.

You may also be given a breakdown of your payments over a certain period of time, so you can see how much you will be paying each month.

Advantages and Disadvantages of Fixed Interest Rates

Main advantages:

Certainty in the amount of payment: The borrower has full transparency over the amount of payment required,because it does not change.

Protection from sudden overnight rate hikes: Borrowers need not worry about overnight rate hikes and their impact on their fixed rates.

Disadvantages:

Potentially higher payment amounts: If overnight interest rates are low, variable rates are likely to be lower than fixed rates.

In addition, it is common for lenders to offer low variable interest rates in the first few years of repayment.

There is no benefit from a sudden drop in overnight interest rates: While a fixed interest rate is exempt from the deleterious impact of an overnight rate hike on variable rates, it is also exempt from the beneficial impact of an overnight rate cut on variable rates.

How to Calculate Fixed Interest Costs

Calculating a fixed interest rate on a loan is relatively simple. You just need to know:

• Loan amount
• Interest rate
• Term

So, assume you take out a debt consolidation loan of $30,000 USD to be repaid over 60 months at 5 percent interest.

Your estimated monthly payment is $566 and your total interest payment is $3,968.22.

This assumes you don't pay off the loan early by increasing the amount of your monthly payment or making a lump sum payment on the principal.

Here's another example. Let's say you get a $300,000 US dollar 30-year mortgage at 3.5 percent interest. Your monthly payments will be $1,347 US dollars and your total mortgage costs including interest will be up to $484,968 US dollars.

So after knowing what a fixed rate interest rate is, check out other interesting news on VOI, it's time to revolutionize the news!