When granting a mortgage, banks leave it up to their customers to choose the type of interest rate. What are variable and fixed interest rates? What are their advantages and when to choose a particular type of interest rate? It is worth choosing consciously, as this decision can determine the real difference in the cost of the loan. Choosing the right type of interest rate could be the answer to the question of how to save money when interest rates are rising.
In simplest terms, a fixed interest rate means that each instalment will be the same amount for the period specified in the contract. A variable interest rate, on the other hand, allows the change of the amount of the instalment you pay. Why the difference and when is it worth choosing a particular type of interest rate?
What is a fixed interest rate on a loan?
The fixed interest rate remains fixed for a certain period of time even despite changes in interest rates, which are decided by the National Bank of Poland’s body, the Monetary Policy Council. As a rule, the period for which instalments are “frozen” is between 5 and 10 years. At the end of this period, the borrower has the right to decide whether to pay the next instalments at variable rates or to freeze the instalments again at current rates.
What is a variable loan rate?
The variable interest rate is the basic and still the most popular condition based on which a loan is set. It is based on prevailing interest rates. Thus, with the Monetary Policy Council’s decision to raise or lower interest rates, the amount of the loan instalment consistently rises or falls. This means that the monthly instalment can fall or rise by as much as several hundred zlotys within a few months, as was the case at the turn of 2021 and 2022.
What type of interest rate should you choose?
When choosing a settlement method, it is worth considering several factors. It should be remembered that the interest rate on a loan is determined by the bank’s margin and the WIBOR rate. The margin is usually a rate calculated individually for each customer, while the WIBOR rate depends on the economic situation in the country. When deciding whether to take out a loan, it is worth taking an interest in the current forecasts relating to interest rates.
A way to save with rising credit rates
The difference between variable and fixed interest rates can best be shown by example. Below is a chart showing the National Bank of Poland’s main interest rate, the reference rate, current as of the month of this article, i.e. May 2022.
After a period of two stagnant interest rates (from 2015 to 2020 and another lasting until the end of 2021), the Monetary Policy Council decided to raise interest rates for the first time in almost a decade. The following months brought further increases. This means that in just a few months, the amount of the average loan instalment increased by several hundred zlotys. This situation has affected those with loans concluded at variable interest rates. If the borrower opted for a fixed interest rate before October 2022, he or she still pays relatively low instalments and will continue to do so until the end of the contractual ‘freeze’ on instalments.
Does a fixed interest rate on a loan pay off?
In the situation described, it was most profitable to take advantage of the fixed interest rate before October 2022, when experts predicted drastic increases in interest rates. What, then, of those who missed this moment? Having the option to opt for fixed interest rates, even in May 2022 it seems advantageous to take advantage of interest rates at 5.25% given the forecasts of further rises of up to 8-10%. It is important to remember that the fixed interest rate is set at a slightly higher level than the current WIBOR level (i.e. higher than the variable interest rate), but in a situation of interest rate rises, it may quickly turn out that WIBOR will exceed the ‘frozen’ interest rate level.
When does a variable interest rate on a loan pay off?
A fixed interest rate seems to be an attractive solution in a situation of interest rate rises. However, it is not always the best solution. In a situation where interest rate cuts are anticipated or when interest rates reach record levels, ‘freezing’ the loan instalment will disadvantage the borrower. While other borrowers will pay lower instalments following interest rate cuts, a borrower with a fixed rate will be obliged to pay the instalment at the level at the time the terms were agreed. In such a situation, a variable interest rate is preferable, because with each reduction in interest rates, the loan instalment will similarly decrease.
Summary
The interest rate on a loan is an important factor affecting the cost of the loan. The right choice between fixed and variable interest rates can make a real financial difference. Depending on the foreseeable near future, i.e. several years, it is worth choosing between fixed and variable interest rates. With a fixed interest rate, the borrower “freezes” the amount of the instalments for a period (depending on the bank) of five to ten years. This makes them independent of interest rate fluctuations linked to interest rate decisions of the Monetary Policy Council. After the contractual period of “freezing” the amount of the instalment, the borrower has to decide whether he wants to pay instalments again at a fixed interest rate (taking into account the current interest rates) or whether he prefers to change to a variable one. Variable interest rates, on the other hand, seem to be a favourable solution, especially when stagnation or declines in interest rates are anticipated.
This article does not constitute credit counselling advice, but aims to give you an idea of the basics of credit. More details will be provided by our advisors, and if you need credit advice, we can help you get in touch with proven experts.
