Loan agreements should specify whether the interest rate the borrower is agreeing to is fixed or variable.
When a loan agreement uses a fixed interest rate, the interest rate will not go up or down over the life of the loan. This allows for a defined, fixed payment schedule and can be attractive to borrowers who want to know that their monthly payments will be fixed.
In contrast, when a loan agreement uses a variable interest rate, that rate will likely change during the term of the loan. When loans are based on variable interest rates, those rates are generally tied to either the prime lending rate or an index. Variable rate loans can be advantageous for borrowers when interest rates go down. However, if the rate rises, the borrower will still need to be able to make his or her payments under the agreement.
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