Unsecured loans come in many formats. There are long- and short-term loans, and then there are loans with adjustable and fixed interest rates.
If you're considering a fixed-rate loan, you likely have many questions like, "Is this the best loan for my purposes?" Or, "What, exactly, is a fixed-rate loan, and how does it work?"
Financing jargon is confusing, so we're here to clarify it. Read on to learn about fixed-rate loans, how they work, and if they're right for you.
What Is a Fixed-Rate Loan?
As its name suggests, a fixed-rate loan has... a fixed rate. This means the loan interest rate doesn't change while you pay it off. You'll pay the same principal and interest each month until you repay the entire loan.
The lender sets the interest rate based on several factors. One of these is the prime rate. The prime rate represents a bank's best interest rate on loans offered to creditworthy customers. The Federal Reserve's Effective Federal Funds Rate often sets the prime rate. But your credit score, income, and repayment ability also determine the interest rate.
Examples of Fixed-Rate Loans
Fixed-rate interest loans are typically associated with expensive goods and services. These can include:
- Auto loans
- Home mortgages
- Student/educational loans
For example, let's say you buy a $50,000 home. You decide to finance the payments with a 60-month loan at a 4.5% interest rate. You would pay approximately $5,929 in interest over the loan's term. On a monthly basis, your principal would be approximately $833.33. On top of this, you would pay an additional $98.82 in interest. You would pay this exact amount for the loan's entire term.
But a fixed-rate loan isn't only for large-ticket goods and services. You can also get a fixed-rate personal loan for smaller investments or emergencies. For instance, you can apply for a short-term, fixed-rate installment loan for up to $4,000 from Jora Credit.
Pros of Fixed-Rate Loans
The main advantage of a fixed-rate loan is its consistent payments. The bi-weekly or monthly payments won't change, even if the prime rate or market conditions do. This stability helps you better budget your expenses.
Furthermore, payments might be smaller, depending on the loan term. A fixed-rate loan can also offer a lower interest rate, meaning more cash for things like an emergency fund or retirement account.
Cons of Fixed-Rate Loans
What is the downside of a fixed-rate loan?
It has a fixed rate.
In other words, it stays the same, no matter what. Even if the prime rate decreases, your loan's interest rate won't. That loan could cost you more money versus a variable-rate loan.
Interest on a variable-rate loan decreases when the prime rate does. The interest rate on a fixed-rate loan does not. If the prime rate falls to 2% and the interest on your fixed-rate loan is 5%, you'll continue paying that 5%.
Another potential problem might occur if you want to repay that loan early. This decision could trigger prepayment penalty charges common for longer-term, fixed-rate loans, like home mortgages. Remember that a few lenders, like Jora Credit, don't assess prepayment penalties with an early payoff.
Requirements For a Fixed-Rate Loan
Your credit history is essential for obtaining a fixed-rate loan. Here are other issues a fixed-rate lender wants to see:
A good credit score. "Good," in this case, means a FICO score of 680 or higher, which tells the lender you have a good mix of credit and a decent history of loan payoffs. You can find your FICO score through your bank or at annualcreditreport.com.
Annual income. Your lender wants to know that you have a reliable income source to ensure you're earning enough to handle monthly expenses. Because of this, the lender might want to see your pay stubs or past income tax returns.
Debt-to-income ratio. Lenders examine your debt-to-income (DTI) ratio to be sure you don't have too much debt relative to what you earn. Lenders like to see a lower DTI, which shows you are in a good position to pay off your loan. You can calculate your DTI by dividing your monthly debt payments (credit cards or other loans) by your gross monthly income.
But what happens if you have bad credit or a high DTI? You might want to wait to apply for that fixed-rate loan. Use the time to pay down credit cards and other debt while getting quotes from other lenders. For example, Jora Credit offers fixed-rate personal loan options for lenders with bad credit. Even better, the on-time payoff of your Jora Credit loan can help your credit score.
When Should I Use a Fixed-Rate Loan?
As mentioned above, fixed-rate loans are common with higher-priced goods and services. But this isn't the only reason to consider this type of financing.
A fixed-rate loan can be ideal in a high-interest-rate environment. If you're confident that the prime rate or other interest index rates won't decrease, fixed-rate financing can be a good choice.
Also, if you want to know exactly how much interest you'll pay over the life of a loan, consider a fixed-rate loan. Another reason to consider a fixed-rate loan is predictability and consistency. You can have peace of mind knowing you'll pay the exact same amount over the loan's term.
Not Just for Big-Ticket Items
You don't need a big-ticket item to apply for a fixed-rate loan. Plenty of personal loans carry fixed rates. Before applying, be sure to understand the loan's purpose. Also, figure out how much you can pay off bi-weekly or monthly. Compare lender rates and gauge market indexes to determine if fixed-rate financing works for you.
Remember that Jora Credit offers plenty of fixed-rate personal loans. Applying takes only a few minutes, and you could receive funding on the same day. For more information, visit Jora Credit today.