A fixed rate loan is one where the interest rate charged is fixed for the entire time of the loan. The advantage is that you are protected to fluctuations in interest rates and can budget your cash outflows precisely. The disadvantage to you is that if interest rates fall, you lose in terms of opportunity costs.

In fact, you can always choose to refinance the fixed rate loan at a lower rate if interest rates fall sharply enough to justify it. Even tough your current lender may charge a pre-payment fee if you choose to repay the loan before due date. So the difference in interest rates between your old fixed rate loan and the new loan should be large enough to justify a loan change.

An adjustable rate loan is a loan that the interest charged fluctuates in line with a benchmark rate. This benchmark rate is usually the Prime Rate, which is what the US Treasury charges its prime borrowers (major banks). The advantage of an adjustable rate loan is that what you are paying is comparatively in line with the market. If interest rates decline, so do your loan costs. The disadvantage is that your cash outflows for interest charges are unpredictable.

As a borrower, if you hold the view that interest rates are going to decline, it is best to select an adjustable rate loan. Predicting interest rates is a place where even professional market participants and institutions frequently go wrong.

If it is important to you to be able to budget for your interest obligations in advance, a fixed rate loan may be the best choice. In case of significantly interest rate decline you can always refinance it.


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