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Fixed interest versus variable interest rates

Katie Schenk - July 31, 2018

Fixed interest versus variable interest rates


If you’re going to take a loan (just about any loan), you’ll need to understand how interest rates affect your repayment.

It’s almost never as simple as saying you’d like to borrow $100 and pay back $110 next week. But, once you break it down, understanding interest rates isn’t terribly complicated either. 

What’s the difference between fixed and variable interest rates?

Interest is the amount that a lender charges to provide you with the funds you need, and it’s expressed as a percentage. There are two significant types of interest rates, fixed and variable

  • With a fixed interest rate, the percent of interest you pay doesn’t change over the duration of your loan. If you accept a loan with a fixed interest rate of 9.5%, the interest rate will always be 9.5% on it, regardless of personal or market factors.
  • Variable interest rates, on the other hand, fluctuate over time. Your interest could be 7.4% for one period and drop to 6.7% in the next. 

Variable interest rates always have two parts: the fixed margin rate, which is determined by your personal financial history and risk, floats on top of a variable base rate.

Common variable base rates are LIBOR, Prime, and MCLR and are widely used by lenders across the globe. On the other hand, the fixed margin applies only to you. 

Together, the two form the variable interest rate provided to you when you apply for a loan. 

How are variable base rates determined?

There isn’t a single equation used to determine base rates. Instead, each one is calculated according to a different set of standards - and by different institutions.

Base rates may be set by:

  • Commercial banks linked to central banks; examples include SELIC in Brazil and MCLR in India,
  • Non-banking financial institutions (NBFCs), or
  • Independent financial institutions, such as LIBOR in the US and UK, Euribor in the EU, and Prime in the US and Japan.

Commercial banks and non-banking financial institution rates might change according to market factors or national fiscal policies. Prime is typically set at three percentage points above the federal funds rate.

On the other hand, rates such as LIBOR (London Interbank Offered Rate) are set according to the independent financial transactions across markets. 

How often do variable interest rates change?

It really depends. 

Some rates change when they work against a country’s monetary goals while others change daily, like LIBOR. MCLR is reviewed monthly and Prime changes periodically, typically in line with the federal fund rates.

Prodigy Finance loans use the relevant 3-month LIBOR (USD or GBP) or Euribor (EUR) rates which means the LIBOR base rate on your loan changes every three months. 

Why do lenders use one or another?

Certain banks and lenders in some countries don’t have a choice in the base rates they use. For example, commercial banks in India are mandated to use the MCLR rate on their loan products.

In other countries, such as the United States where there is a choice of Prime and LIBOR, banks can choose which benchmark base rate works better for them. LIBOR is becoming increasingly popular as it’s more fluid and enables banks to keep pace with current market movements. 

How to compare variable interest rates versus fixed interest rates?

You can’t use interest rates alone to compare loan with each other; there are other variables in play, including the principal (amount disbursed), related fees, and the loan repayment period. All of these affect the total cost of your loan and to factor them in, Annual Percentage Rate (APR) is used.

APR takes into account the interest rate and the fees associated with a loan and provides a complete picture of costs. It’s used to compare loans to each other - and in countries like the US and the UK, it’s a legal requirement to provide APR to borrowers as it ensures transparency.

APR is critical to understand, and you may want to take a few moments to learn more; it may just help you choose the right loan for you.

Are fixed interest rate loans or variable interest rate loans better?

Not everyone has a choice between fixed and variable interest rate loans. For those that do, keep in mind that you shouldn’t make a decision based on the interest rate alone. While APR is useful for comparing loans to each other, there are additional factors in play such as repayment duration and any additional benefits that may come with an offer.

It’s better to compare individual loans with each other to make the best financial choice for you than to based on whether a product has a fixed or variable interest rate. However, you should consult a registered, trusted financial advisor if you need assistance comparing loan products.

If you have any questions on Prodigy Finance loans, take a look at our FAQs or send an email to info@prodigyfinance.com.

 

Ready to see the APR Prodigy Finance can offer you?

Prodigy Finance offers international student loans and refinancing options for masters-level education at top universities across the globe.


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