What Is a Fixed-Rate Personal Loan and How Does It Work?
Updated: March 28, 2024
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Funding a significant expense, such as home improvement or a major life event, often leads to exploring various borrowing options. Fixed-rate personal loans stand out for their consistency. These loans lock in an interest rate for their entire term, making them ideal for people who value a stable repayment plan, allowing for precise budgeting and financial planning.
However, fixed-rate personal loans may not suit everyone. It’s important to understand how they work, plus their benefits and drawbacks, to determine whether this option aligns with your financial goals and happiness.
How Does a Fixed-Rate Personal Loan Work?
A fixed-rate personal loan has an interest rate that remains constant throughout the loan's duration. This removes the guesswork of fluctuating payments, giving you a clear and steady path to manage your larger financial commitments.
Suppose you’re starting an expensive home renovation project. By opting for a fixed-rate personal loan, you secure funding with the peace of mind that the interest rate will never change. This is particularly beneficial in an economic climate where interest rates are unstable. With a fixed-rate loan, your monthly payments are set in stone from the outset, unaffected by market variation.
Typically, fixed rates for personal loans move in the same direction as overall interest rates. The Federal Reserve sets a benchmark rate that influences many other rates. And when the Fed raises their benchmark rate, personal loan fixed rates tend to go up as well usually within 6-12 months. If the Fed lowers their rate, personal loan fixed rates will tend to drop as well. — Alvin Yam, CFP®
The predictability of a fixed-rate personal loan allows you to calculate its financial impact on your monthly budget for the entire repayment period. You can plan ahead, knowing that your loan payments will remain constant.
Comparing Fixed-Rate Personal Loans With Other Loan Types
Understanding the differences between fixed-rate personal loans and other types of personal loans will help you make more informed financial decisions. Each loan type has unique features regarding interest rate stability, loan length and repayment terms. Choosing the right option depends on your financial situation, goals and preferences.
While fixed-rate personal loans provide the certainty of unchanged monthly payments throughout the loan term, variable-rate loans have payments that can change with the market. This variability can be a challenge for those who prefer a predictable budget.
Personal lines of credit offer a different kind of flexibility compared to fixed-rate personal loans. These allow you to borrow as needed up to a certain limit, typically with variable interest rates. Home equity loans offer a point of comparison in their potential for stable repayment terms. However, unlike most fixed-rate personal loans, home equity loans are secured against your home, which carries a different level of risk.
Benefits and Drawbacks of Fixed-Rate Personal Loans
While the benefits of a fixed interest rate can be appealing, always consider how this type of personal loan aligns with your financial goals, risk tolerance and future plans. Weighing the advantages and disadvantages helps in determining if this option is the best for your particular situation.
When Should You Get a Fixed-Rate Personal Loan?
A fixed-rate personal loan may not be the ideal choice for every situation. It's important to understand when and how opting for a fixed interest rate can maximize the benefits of your loan.
You Have Specific, Long-Term Financial Goals
If you're planning for long-term financial goals, a fixed-rate loan can be beneficial. Its unchanging interest rate provides a reliable framework for financial planning over several years. This stability aligns well with long-term goals, ensuring no unexpected changes in your repayment schedule.
You Prefer Stable and Predictable Monthly Payments
For those who value a consistent budget plan, fixed-rate loans are ideal. The certainty of the same payment amount each month simplifies financial management and helps avoid surprises in your budget.
You Have the Opportunity to Lock in a Low Rate
In a low-interest-rate environment, securing a fixed-rate loan can be advantageous. By locking in a low rate, you protect yourself against future rate increases, potentially saving money over the loan term.
You Don’t See Any Significant Market Signals That Are Beneficial to Variable-Rate Loans
When market trends don’t strongly indicate that rates will fall significantly, opting for a fixed-rate loan can be more financially sound.
Consider consolidating your high-interest debt, like credit cards, into a fixed-rate personal loan (which typically have lower interest rates). This could potentially save you thousands in financing costs over time. — Alvin Yam,CFP®
How to Get a Fixed-Rate Personal Loan
Understanding the process of getting a personal loan with a fixed interest rate is important because it helps prepare for the requirements and expectations involved. A well-informed approach can streamline the application process, improve your chances of approval and ensure you get a loan that best suits your financial needs.
Assess Your Loan Eligibility
The first step in getting a fixed-rate personal loan is to see if you qualify. This depends on a few important things, such as:
Credit Score: Your credit score reflects your creditworthiness based on factors such as payment history, the amount of debt you currently carry and the length of your credit history. For fixed-rate personal loans lenders typically look for a minimum credit score between 580 and 669 for fixed-rate personal loans.
Income: Lenders need to verify that you have a steady income to cover the loan payments. Your income level helps them determine how much you can afford to borrow while managing your other financial obligations.
Debt-to-Income Ratio (DTI): This is compares your monthly debt payments with your monthly gross income, expressed as a percentage. It measures your ability to manage monthly payments and repay debts. A DTI ratio of 36% or lower is preferred by lenders, as it suggests that you’re more likely to manage loan payments effectively.
Employment History: A stable employment history indicates to lenders that your income is consistent and reliable. Lenders may look for at least two years of steady employment in the same field or with the same employer as part of their assessment.
Understanding and reviewing these factors before applying can give you insight into your eligibility and the terms you might receive. Improving your credit score, reducing your DTI ratio or stabilizing your employment situation can enhance your chances of approval and potentially secure a loan with more favorable terms.
Research Potential Lenders
Look into various financial institutions, including traditional banks, credit unions and online lenders, to find the best fixed-rate loan options. Compare their interest rates, loan terms and fees and penalties. Thorough research ensures you find a lender that offers favorable terms and rates that align with your financial goals.
Gather Necessary Documentation
Prepare the required documents, which typically include:
- A completed loan application form
- Social Security Number
- Your proof of identity (driver’s license, passport and other IDs)
- Your proof of income (recent pay stubs, W-2 or 1099 forms, tax returns from the last two years)
- Your proof of address (utility bills, a lease agreement, mortgage statements, etc.)
- Bank statements
Some lenders may look for additional documents, especially if you’re self-employed. It’s best to ask what they need to avoid any delays in your application.
Apply for the Loan
Complete the loan application online or in person, providing all the necessary personal and financial information. Be thorough and accurate in your application to avoid delays or rejections. Some lenders might offer a prequalification process to give you an idea of the terms you qualify for without hurting your credit score.
Review and Accept the Loan Terms
Once approved, carefully review the loan agreement. Make sure to keep an eye out for the interest rate, repayment schedule and any fees or penalties. Ensure you understand all the terms and conditions before accepting the loan. This final step ensures you are fully aware of your obligations and the loan aligns with your financial plan.
If you’re interested in getting a fixed-rate personal loan, it’s important not to opt for the first offer immediately. Below are a few starting points to compare lenders:
- Compare interest rates of variable-rate personal loans: A variable rate can be beneficial in some cases, such as if the interest rates are lower or you anticipate interest rates going lower in the future.
- Opt for flexible payment terms: Some lenders allow you to choose the term length that best suits your needs.
- Assess your ability to repay the loan: It’s important to consider whether you can repay the loan based on the interest rate and the term. You don’t want to take on a loan if your finances are unstable.
- Determine application and funding speed: If you’re in a rush, it’s important to choose a lender whose application period and funding disbursement time are short. Ask ahead to see the estimated time frame of your desired lender.
Frequently Asked Questions About Fixed-Rate Personal Loans
When deciding if a personal loan is right for you, one of the most important decisions you will make is whether to opt for a fixed interest rate. It can sometimes prove worthwhile, but individual needs and circumstances vary. Learning the answers to other frequently asked questions about fixed-rate personal loans can help you determine the best course of action.
This depends on your lender. It is not common to change from a fixed rate to a variable rate. It is more common to switch from a variable to a fixed rate.
Yes, it’s possible to make extra payments towards your personal loan. Make sure to speak with your lender to understand the terms and conditions of repayment.
It depends. Your interest rate will depend on your income, credit score, DTI ratio and other factors. Whether a variable or fixed rate is lower will also depend on external factors, such as the market and the underlying benchmark your desired lender uses.
Yes. However, some lenders may impose a prepayment penalty fee, so you should check the fine print or ask your lender directly about the conditions.
Once you’re done repaying your loan, the account will close.
Lenders look at several factors to determine your fixed interest rate. Aside from working with a range based on their benchmarks, they also use your credit score, income, DTI ratio and employment history. The exact formula that is used to determine your rate will vary from lender to lender.
Missing a payment can result in late fees, and it may negatively impact your credit score. Your lender might also contact you to arrange payment. If you continue to miss payments, your loan could go into default, which can trigger collection actions, including wage garnishment or asset liens.
The content on this page is accurate as of the posting/last updated date; however, some of the rates mentioned may have changed. We recommend visiting the lender's website for the most up-to-date information available.
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