Interest Rates: Understand What Influences Fixed and Variable Rates

4 MIN. READ

Key takeaways:

• The cost of borrowing can vary a lot based on the APR your lender offers.
• Your interest rate can vary based on external and personal factors; however, the type of loan you apply for is also a significant consideration.
• Join us as we explore the various factors influencing fixed and variable interest rates.

Can you save more with fixed or variable interest rates?

It depends. Picking a loan with fixed or variable APR is an important decision, and before you settle down, you should know a little bit more about what influences interest rates and what the real difference between fixed and variable interest rates is.
 

Fixed Vs. Variable Rates: What’s the Difference?

The difference between fixed and variable APRs is pretty straightforward:
 

• If you apply for a loan with fixed interest, you’ll agree to an APR when you sign the loan document. This APR will remain constant throughout the entire loan term.
• If you opt for a loan with a variable interest rate, your lender will adjust your APR periodically. Your interest rate may fluctuate depending on market conditions.

In short, a fixed loan is a great pick if current rates are low, while a variable loan makes more sense if there is a chance that rates will drop in the future. To figure out if that’s likely to happen, you need to know what really influences interest rates.
 

What Affects Loan Rates? (External Factors)

We should start by discussing external factors, as you are likely familiar with the Fed's interest rates.

The truth is that the Fed (short for the Federal Reserve System) sets interest rates for banks and credit unions that borrow money. If a lender has to spend more to borrow money, they will, in turn, raise the APR on their loans. However, the impact is usually stronger for short-term loans and products with a variable APR. For instance, the Fed's rate would have more of an impact on a variable-rate HELOC compared to a mortgage.

There is another external factor more important than the interest rates set by the Feds: Offer and demand.
 

• If demand for loans increases, lenders will likely raise the rates they offer.
• When demand slows down, APRs and lending fees tend to drop to attract borrowers.

Offer and demand are shaped by many economic factors, such as the job market, the current state of the housing market, and inflation.
 

Why Your Financial Profile Matters More Than External Factors

These external factors have an impact on the cost of borrowing, but you can still secure a good APR if you have a strong financial profile. You might need a higher credit score or larger down payment for a great rate when external factors aren’t ideal for borrowing, but keep in mind that these are the things you have control over.

Your credit score is obviously a major consideration for lenders, and taking a few simple steps to improve it before applying for a loan can make a real difference.

Beyond your credit score, your lender might look at your income, your employment history, and your debt-to-income ratio. Credit unions are far more likely to review all these things and take the time to get a more nuanced view of your financial profile.
 

Why The Type of Loan You Apply for Influences Interest Rates

Your financial profile and the current state of the economy have a strong influence on how much it costs to borrow money. However, the most important factor is the type of loan you apply for.

It’s because banks and credit unions look at lending you money as a risk they take. If the risk is low, they can offer a lower interest rate. Risk is assessed based on the external and personal factors we discussed above, but some loan types carry more risk than others.

Here’s what to consider:
 

• Are you applying for a secured or unsecured loan? Securing a loan with an asset is one of the most common strategies for lowering the risk your lender takes and getting a better APR.
• What are you borrowing the money for? If you’re interested in a boat or RV loan, expect to spend more on your APR since these assets depreciate faster than cars or homes.
• The term (or duration) of your loan also matters. Short-term loans usually come with lower interest rates because your ability to pay the loan back is less likely to change over a short time period.
• The amount you’re borrowing is another important consideration. The more you borrow, the higher the risk your lender takes. Saving up for a larger down payment is the best way to minimize this risk and keep your APR low.

Why You Should Borrow From a Credit Union

The last factor that influences interest rates is the lender you pick. For instance, online lenders can be aggressive with their APRs because they need to recoup the cost of advertising for their services, and major banks can raise their interest rates to generate more profit.

Thanks to their not-for-profit model, credit unions can offer lower rates and even pass on savings to their members in the form of lower APRs when they generate a surplus of money.

At Power Financial Credit Union, we follow this model and offer affordable loan options, both with fixed and variable interest rates. Plus, we always take the time to review applications with care and offer a fair APR based on each member’s unique financial situation.

Whether you’re looking for a credit card, a mortgage, a car loan, or a recreational loan, we can have affordable options available. Contact us online or visit one of our South Florida branches today to learn more about becoming a member and applying for a loan.
 

FAQs

What's the main difference between fixed and variable rates?

Fixed rates stay the same throughout your loan, while variable rates change based on market conditions.
 

When should I choose a fixed rate over a variable rate?

Choose fixed rates when current rates are low. Variable rates make more sense if you expect rates to drop in the future.
 

What factors affect my interest rate the most?

Your credit score, the type of loan, and whether it's secured or unsecured have the biggest impact on your rate.
 

Why do credit unions typically offer lower rates?

As not-for-profit institutions, credit unions can pass savings to members rather than generating profit for shareholders.