Baskadia

According to bank of Zambia’s credit monitoring report, in quarter four of 2023, Zambia recorded 938,368 credit disbursements to individuals and households (Bank of Zambia, 2023). Going by past trends, this number will continue to grow as more individuals continue to gain access to credit products.

While they are many factors to consider when deciding which credit product best suits an individual’s personal needs; in this article, I will focus the type of interest attached to credit i.e. fixed interest rates and variable interest rates, and why the choice between the two is crucial in credit lending.

DEFINITIONS

Interest rates are as rates payable on debt and deposit obligations by the borrowers to the lenders (Faure, 2014). In non-technical language is it a reward paid by the borrower to the lender for the use of their money over a period of time i.e. the price of money. Building on this we can further define fixed interest rates and variable interest rates.

1) Fixed interest rate; is a specific amount attached to a loan that is paid along with the amount being borrowed; the amount stays the same despite market fluctuations(Standard Bank, n.d.). What this implies is the loan installment charged every month would be constantthroughout the loan term.

2) Variable interest rate; with this rate the amount you pay is tied to a base interest rate, called prime interest rate, and what is paid depends on its movement and fluctuations(Standard Bank, n.d.). What this implies is the loan installment charged every month can go up or down based on the current market conditions ( government policies, economic trends, supply & demand)

DIFFERENCES

Having an understanding on the types of interest applied on credit on product, we can further highlight the differences between the two that a user must consider.

A) Cost of credit. Fixed interest rate are generally set higher than the variable interest rate, this is because higher interest rate acts as a buffer, on the side of the creditor, protecting them from potential negative change in market conditions. Variable interest rate on the other hand offers lower rates;this is because the risk of change in market conditions is borne by the debtor.

Cost of credit may include other aspects such as management fees, insurance on credit products etc.

B) Stability. Fixed interest rates offer debtors predictable and stable repayments throughout the term of the loan, this allows for easy planning and budgeting. Variable interest rates on the other hand have uncertainty in repayments making it difficult for long term planning and budgeting.

C) Understandability. Fixed interest rates may be easier to understand by first time borrowers and individuals who donot have adequate knowledge of financial market trends. Borrowers may find managing and understanding the variability of variable interest rates to be complicated and time consuming as they require them to be informed about

In summation next time you are considering a credit product ensure you find out what type of interest rate used as it will reflect; the cost of credit and in turn the total amount to be repaid, ease & stability of loan repayment as well as the volatility of interest in relation to market conditions.