Loans & Credit

What are fixed vs variable interest rates?

If you’re looking to buy a house or car or sign up for a credit card or loan, you could be asked whether you want a fixed or variable interest rate.

Understanding the role of interest when borrowing money could help you (a) make an informed and better financial decision and (b) get a better deal when applying for a loan.

Here are a few key things to know about interest rates and how fixed and variable interest rates fit into the mix. We also cover what the pros and cons of each are so you can decide which one is right for you.

Unpacking interest

Interest is what you pay to the lender on top of the amount borrowed: you’re paying for the privilege to borrow money for a specific period at a specific price. There are different factors that influence how much interest is paid, which include the following:

How much money you’re borrowing
The period in which it needs to be paid off
How much other debt you have and the state of your credit score

Different types of interest come into play when you decide how you want to structure those payment instalments. Does it suit you to pay the same amount every month so you can factor it into your budget, or are you okay with paying a different amount every month and taking a chance that the market conditions might change, meaning that you’ll pay a lower or higher amount?

Prime interest

The prime interest rate is the benchmark interest rate that banks and financial institutions use to set the interest they charge you on loans and credit cards. Prime is linked to the repo rate and therefore can go up or down, influencing how much interest you’re paying.

Prime plus: When the interest rate on a loan or credit product is charged at a certain percentage point higher than prime. For example, if the prime lending rate is 11.75% and the offer is prime plus 2, it means you’ll be paying 13.75%.
Prime minus: When the interest rate on a loan or credit product is charded at a certain percentage point lower than prime. For example, if the prime lending rate is 11.75% and the offer is prime minus 1, it means you’ll be paying 10.75%.

Fixed interest

A fixed interest rate is a specific amount attached to the loan that must be paid along with the amount that’s being borrowed. The interest amount stays the same regardless of market fluctuations or economic conditions. Therefore, included in your instalments every month will be a set amount of interest that’s the same throughout the term of your loan.

The pros

You keep paying the same amount regardless of changes in the market. If prime interest rates go up, you carry on paying the same amount.
It’s easier to budget because you know exactly how much you need to pay every month.
It’s easy to understand, predictable and a stable option.
When the prime interest rate increases, then fixed interest will benefit borrowers as they won’t experience that increase.

The cons

There’s less flexibility in your repayment terms.
If you sign up for fixed interest and the prime interest rate decreases, you’ll still pay the same amount without the option for it to decrease.
Depending on the conditions, it might work out to be a more expensive option over the life of the loan.

Variable interest

With variable interest, the amount you pay is tied to a base interest rate, called the prime interest rate, and what you pay is determined by the movements and fluctuations of that amount.

For example, if you’re paying R5 000 pm on your car and the interest rates go down, the prime lending rate goes down, and your monthly instalment might be less. The opposite is also true: if interest rates rise, then your monthly payments will also increase accordingly.

The pros

Payments decrease when interest rates decrease.
Variable interest rates can be lower than fixed, which means the overall loan repayment is less.
If you’re lucky and the interest rates stay low, you’ll pay less for the loan than initially anticipated.

The cons

If interest rates suddenly increase, and possibly increase again on top of that, your monthly payments will be more, and the total loan repayment could be more.
There is uncertainty, and it can be difficult to manage your budget.

_{Disclaimer: This article is solely intended for information. It does not constitute financial, tax or investment advice or recommendation. Please speak to a financial advisor or registered financial professional before making any financial decision(s).}

_{Standard Bank, its subsidiaries or holding company, or any subsidiary of the holding company and all of its subsidiaries make no warranties or representations (implied or otherwise) as to the accuracy, completeness or fitness for purpose of the information provided in this article or that it is free from errors or omissions.}