Variable-rate vs. fixed-rate loans

When interest rates go up or down, it impacts the cost of taking out a new loan. For some, it may also affect the interest on a current loan or credit card.

What should you do when interest rates shift? It starts with understanding whether your loan has a fixed rate or a variable rate. Learning more about your loan and the options available to you helps you make better decisions that could save you money.

What’s the difference between a variable-rate loan and a fixed-rate loan?

• Fixed-rate loan: Your interest rate won’t change. It’s determined when the loan is taken out, and it remains steady for the life of the loan.
• Variable-rate loan: Your interest rate may change over time in response to changes in market conditions.

When interest rates rise, check your current loans. If you have a variable-rate loan, it may be worth looking into options available to you.

What are examples of variable-rate loans?

From homes to credit cards, variable-rate loans are a common option for many types of financing. Also known as adjustable-rate loans, examples can include:

• Credit cards
• Home equity lines of credit (HELOCs)
• Personal lines of credit
• Some SBA and commercial loans

What is an interest rate?

The interest rate is the price you pay for borrowing money. When you have a loan, there are 2 things you pay back to the borrower over time:

1. The original amount you borrowed

2. Interest — a percentage of the loan amount

The amount of interest you pay depends on several factors, such as your credit score and loan type. And with variable-rate loans, the cost of interest is designed to change based upon market conditions. 

How are interest rates set on variable-rate loans?

There are 2 components to the interest rate on a variable-rate loan:

1. Index: This is a benchmark interest rate that generally reflects what’s happening in the market. The most common index is the prime rate — also known as the Wall Street Journal Prime Rate. It is based on a regular Wall Street Journal survey of the rates banks charge their best customers. View the current prime rate.

2. Margin: This represents percentage points added to the index by a lender. It can vary based on several factors, including loan type and the lender’s confidence in your ability to repay the loan. Unlike the index, the margin is likely to remain constant for the life of your loan. For loans with open access, such as a credit card, it is possible for the margin to be adjusted by the lender through an official “change in terms.” In these cases, any margin changes would be communicated well in advance and would include an option for the line to be closed before the changes take effect.

What causes my interest rate to change?

Since the margin is set, you want to watch for changes in your index rate. This rate typically fluctuates as the Federal Reserve Bank changes the federal funds rate. Take note when interest rates are rising. It could impact the cost you are paying for your loan.

Is a rising interest-rate environment common?

A period where interest rates go up — or down — is actually quite common. This is because the Federal Reserve adjusts rates in response to its dual roles:

1. Keep prices stable (control inflation)

2. Boost jobs (control unemployment)

The Fed tends to boost rates when prices start soaring. Think of the “Great Inflation” period in the early 1980s or the housing market boom of 2005-2006.

The Fed tends to cut rates in times of uncertainty, which usually impacts hiring. For example, the rate dipped more than 5 points from 1990-1992 during the Gulf War Recession. It dropped 4.75 points in 2001 alone between the dot-com bust and 9/11.  

At the onset of the COVID-19 crisis, rates were already low. But they were cut even lower. Coming out of the pandemic, prices soared while unemployment remained low. This led to a rising-rate environment in 2022 and 2023. 

What are my options if my interest rate goes up?

It’s wise to look closely at your account details.

Consider being more cautious with your spending

When rates increase, consider paying down your credit card or line of credit balances. These types of products only charge interest when balances aren’t paid in full each month. It’s also smart to think twice or consult a trusted advisor before adding new debt.

Look into the options available to you

Numerica team members can help you evaluate questions like:

• Would you like to flip your current HELOC balance to a fixed-rate loan?
• Is it possible to consolidate variable-rate loans into a fixed-rate personal loan?
• Would equity available in your home or vehicle help you refinance your credit card debt?

What else is impacted by rising interest rates?

When interest rates go up, it’s worth taking a look at all aspects of your finances — not just loans. Your deposit accounts like savings or a money market may benefit. Call your financial institution to ask about savings account options that could increase your rate of return.

The bottom line: Be proactive, do your research, and discuss your options with an expert you trust. Numerica is here for your financial well-being. Give us a call at 800.433.1837 or stop by your local branch.