Variable vs. fixed interest rates

If you've ever taken out a loan or opened a savings account, you might be aware that financial institutions will often present you with the option to take a variable interest rate or a fixed interest rate. It's important to know the pros and cons of both because there isn't a right or wrong decision; which one you should choose will depend on your personal circumstances.

What is a variable interest rate?

A variable interest rate (also known as an adjustable/floating/linked rate) is an interest rate that may change over time. It's based on the country's current repo rate set by the South African Reserve Bank. If you take out a loan with a variable interest rate, your monthly repayments will be affected by the country's repo rate – if the rate goes up, so do your repayments, and vice versa. By the same token, if you have a savings account with a variable interest rate, you'll earn more interest if the interest rate goes up, and less if it goes down.

What is a fixed interest rate?

A fixed interest rate doesn't change over a set period of time of a loan or savings account. It's not linked to the repo rate and is not affected whether this goes up or down. Fixed interest rate options on savings accounts are decided at the start of the savings agreement. There is often less risk involved in a fixed-rate savings account, but if the repo rate goes up, you'll miss out on potential savings.

Which one should you choose?

Whether you're taking out a loan or opening a savings account, there are a few factors to consider. For example, how long are you saving or borrowing money for? Is the repo rate likely to go up or down in the future and by how much? Which option gives you a better deal over the term of the loan or savings account? If the interest rate changes, can you afford the higher repayment amount or lower interest earned on savings? There isn't a hard-and-fast rule here – it really depends on your circumstances.

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Sources: Investopedia; Business Tech; Investec

Prices quoted are correct at the time of publishing this article. The information in this article is provided for informational purposes only and should not be construed as financial, legal, or medical advice.