Fixed and variable interest rate loans
Your lender may offer you a choice between a fixed or variable interest rate loan. Let’s break down the two types.
Fixed interest rate loans
Fixed-rate loans lock in your interest rate for the term of your loan.
The term is the length of the payback period. Loan terms, for example, could range from 12 months to seven years. This gives you the flexibility to help meet your monthly budget and find a payment you can afford.
With fixed-rate loans, you’ll know exactly how much principal and interest you’ll be paying with each regular payment during your borrowing term. With a fixed-rate loan, you’ll know when you’ll have fully repaid your debt.
Variable interest rate loans
Variable interest rates are usually affected by the prime rate. They go up or down when the prime rate changes. If the variable interest rate decreases, more of your payment goes towards the principal and you’ll pay off your loan faster.
Depending on your loan agreement, your payments could increase when rates go up. Or they could remain the same, but the time it takes to pay back your loan may increase. If you’re unsure, check with your lender before signing.
The prime rate is set by your lender and is influenced by the Bank of Canada’s interest rate. The Bank of Canada is Canada’s central bank.
There’s typically a domino effect when the Bank of Canada changes its interest rate. Most lenders will adjust their prime rate after the Bank of Canada changes its interest rate.
Variable interest rates are typically expressed as prime plus or minus a certain percentage. They’re usually lower than fixed interest rates, in part because they can be riskier for borrowers.
Source: Protecting yourself if interest rates rise, Financial Consumer Agency of Canada.