Business Loans: Fixed Rate vs. Variable Rate

When taking out business loans, borrowers have the option of choosing between a fixed interest rate and a variable interest rate. Both rates depend on the market interest rate, the borrower's credit score, the term of the loan, and the overall amount of the loan. Both rates are contracted between the lender and the borrower and can differ between lenders. Although similar in certain aspects, fixed interest rates and variable interest rates carry different advantages and disadvantages for the borrower. 

Fixed Rate Loan

A fixed rate loan carries a constant interest rate for the entire term of the loan. Fixed rate loans usually have terms ranging from 10 to 50 years with the most common type being a 30 year loan.   

Advantages of a Fixed Rate Loan

Dependability is the biggest advantage of fixed rate loans. The borrower does not need to worry about rising market interest rates because, no matter the state of the economy, the interest on the borrower's loan will not change. The borrower's monthly payments never change, even if the market rate goes up and therefore planning for other financial commitments is easier to do.   

Variable Rate Loan

Variable rate loans start with one interest rate and then, in a predetermined period of time, charge a different interest rate. The interest rate on the loan is determined by an index such as the Certificate of Deposit Rate or the Bank Bill Swap Rate. 

Advantages of a Variable Rate Loan

Variable rate loans provide borrowers with initially very low interest rates that are usually significantly lower than the market interest rate on fixed rate loans. Borrowers who take out a variable rate mortgage loan benefit the most if they plan on moving during the initial period of the loan when interest rates are still extremely low. For a borrower who is just beginning to earn an income, variable rate loans allow him or her to pay a small amount when cash flow is minimal and a larger amount when cash flow improves. With a variable rate mortgage loan, low initial interest rates mean that a borrower may be able to afford a more expensive home with the money saved in monthly payments.