When it comes to loan interest rates and repayments, things can get pretty confusing, pretty quickly. Understanding the difference between a fixed and a variable interest rate, as well as what a balloon payment is, can help you save money in the long term by picking an option that suits your needs.
What is the difference between a fixed and variable rate?
There are a number of differences between fixed and variable interest rates. These differences can mean one type of interest rate may be better suited to your needs, depending on the type of loan (e.g. for car, home, business loan, or asset finance etc.) as well as the life of the loan.
Fixed interest rate loans
As the name suggests, a fixed rate loan is a loan where the interest rate charged will remain the same for a specific period of time, usually between 1 and 5 years.
This type of interest rate is not subject to fluctuations in the market, meaning you will know what your repayment is across the life or fixed period of your loan.
From a practical sense, this type of interest rate may allow you to lock in lower repayments (assuming the market interest rate is low) even if market rates increase.
Of course, you also run the risk of locking in an interest rate, only for the market to drop and interest rates to become lower than what you have committed to¹.
Some loans and finance options may only offer an effective fixed interest rate, for example a chattel mortgage, finance lease or hire purchase.
Variable interest rate loans
A variable interest rate loan has a rate that fluctuates with the market.Your repayments on the outstanding loan balance will vary with a variable interest rate loan.
This fluctuation will be based on whether the lender decided to increase or decrease the variable interest rates¹. Variable rates are not available for all loans. For example, a chattel mortgage, finance lease or hire purchases generally have fixed interest rates that apply for the life of the loan.
Which is going to be right for you?
Deciding on which type of loan is right for you is going to depend on your circumstances, your requirements and needs at the time you take out a loan.
If the market interest rate is low, but predicted to rise, it may make more sense to take out a loan with a fixed interest rate. This will ensure you are going to be paying a lower amount of interest, even if the market rate increases.
However, if the market interest rate is predicted to drop at the time you wish to take out a loan, it may make sense to commit to a variable interest rate.
This will ensure you reap the benefits of any fall in market interest rates, meaning you’ll pay less over the lifetime of your loan (assuming the market remains low).
Doing the right amount of research and working with your broker can help inform you of the right loan for you or your business.
What is a balloon payment?
Balloon payments are a specific type of payment that are offered on some types of loan.
This type of loan requires that a large, lump sum is paid at the end of the loan term - usually as the final payment.
Loans with a balloon payment are different from regular instalment loans, which see the same, or similar sized payments made across the life of the loan until the owing balance is $0.
A balloon loan term will generally be shorter than a regular instalment loan and a portion of the loan balance is amortised during the term. This allows the borrower to reduce the initial repayments made on a loan.
Many people and businesses opt for balloon loans to purchase cars and equipment. The balloon amount is generally based on an estimate of the value of the car or equipment at the end of the loan period, and that amount is set as the balloon payment owing at the conclusion of the loan.
It’s important to note that at the end of the loan term, the value of car or equipment may be less than the final balloon payment owed.
At the end of the loan term, you may choose to sell the car or equipment to pay off the remaining loan amount or make the final balloon payment and keep the car or equipment.
If you sell the car or equipment and it is less than the amount you owe, you would still need to pay the difference.
How to decide what’s right for you
Deciding on the right loan type for you will come down to your individual or business circumstances.
Doing a good amount of research and finding the right product will mean you could save money and ensure you’re able to pay back what you owe.
If you’re feeling overwhelmed about the options and feel you need assistance, speak with an Aussie Broker who will be able to guide you through the processes involved in taking out a loan.
