Variable vs Fixed Rates: How It Impacts ISA Returns

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Published on February 5, 2025

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Variable vs Fixed ISA Rates

When choosing an ISA (Individual Savings Account), one of the biggest decisions you’ll make is whether to go with a fixed or variable interest rate. Both have their pros and cons, and the best choice depends on your financial goals, market conditions, and risk appetite.

Right now, with the Bank of England (BoE) interest rate sitting at a higher level, this decision is even more critical. A high BoE rate means variable rate ISAs can seem more attractive at face value, but they come with risk. On the other hand, fixed ISAs guarantee a return but often at lower rates when interest rates are high. Banks, of course, make money in both scenarios, and understanding how can help you make the smartest decision for your savings.

Variable vs Fixed ISA Pros and Cons

Fixed Rate ISAs

A fixed-rate ISA locks in your interest rate for a set period—typically 1, 2, 3, or 5 years. This means you know exactly how much interest you’ll earn over time, regardless of what happens with interest rates elsewhere.

Pros of Fixed ISAs:

✔️ Guaranteed return—no surprises.

✔️ Great if you expect rates to drop in the future.

✔️ Encourages long-term saving and discipline.

Cons of Fixed ISAs:

❌ If interest rates rise, you’re stuck with a lower rate.

❌ Your money is locked in—withdrawals usually result in penalties.

❌ In a high-interest environment, you might earn less than someone on a variable rate.

Variable Rate ISAs

A variable rate ISA means the interest rate you earn can rise or fall over time. It typically tracks the Bank of England base rate but at a slight discount—often 0.5% to 1% below the BoE rate.

Pros of Variable ISAs:

✔️ Interest rates often start higher than fixed ISAs, especially when the BoE rate is high.

✔️ If rates go up, your returns could increase.

✔️ More flexibility—many allow withdrawals without penalty.

Cons of Variable ISAs:

❌ If the BoE cuts interest rates, your returns will shrink over time.

❌ Less certainty—you don’t know exactly how much you’ll earn in the long run.

❌ Banks tend to offer lower rates than the BoE, meaning your growth is always slightly limited.

Why Fixed ISAs Offer Lower Rates

At first glance, it might seem odd that fixed-rate ISAs offer lower rates than variable-rate ISAs when interest rates are high. But there’s a simple explanation:

Banks know that interest rates will eventually fall. By locking customers into a lower rate today, they guarantee themselves a profit when BoE rates eventually drop.

Example: How Banks Make Money on Fixed ISAs

Imagine the BoE rate is 5%, and a bank offers you a fixed-rate ISA at 4% for five years. You might think:

“Why would I accept a lower return?”

The answer: because in five years, the BoE rate might have dropped to 2%—meaning your 4% fixed return is actually a great deal in hindsight. The bank, however, locks in its profit by lending your money out at higher rates in the meantime.

Now, let’s flip the scenario.

How Variable Rate ISAs Can Be a Trap

A variable-rate ISA looks amazing when interest rates are high. Imagine a bank offering a variable rate ISA at 4.5%when the BoE rate is 5%.

That’s great—for now.

But if the BoE decides to cut interest rates next year to 3%, your return will shrink accordingly. In two years, you could be earning only 2%—a far cry from the tempting 4.5% you initially signed up for.

How Banks Profit from Variable ISAs

Banks set their variable rate ISAs slightly lower than the BoE rate, say 0.5%-1% below it. So if the BoE rate is 5%, they might offer 4% on a variable ISA.

Here’s the trick: when rates fall, they adjust customer rates quickly, but they don’t always pass on the full benefit when rates rise. This lag lets them squeeze extra profit over time.

Which One Should You Choose?

It depends on your goals, but here’s a simple way to decide:

If you think interest rates will stay high or go higher → A variable ISA might be better.
If you think rates will fall over the next few years → A fixed ISA might be the safer bet.

Practical Scenario 1: The Saver Who Chooses a Fixed ISA

Sarah deposits £10,000 into a 5-year fixed ISA at 4%.
She earns £400 per year, regardless of what happens to BoE rates.
If the BoE rate drops to 2%, she’s still earning 4%, which is a great deal.
However, if the BoE rate jumps to 6%, she’s stuck earning less than she could have with a variable account.

Practical Scenario 2: The Saver Who Chooses a Variable ISA

John puts £10,000 into a variable ISA starting at 4.5%.
In year one, he earns £450.
In year two, the BoE cuts rates, and his return drops to 3.5%.
In year three, his return drops to 2.5%, and he starts regretting not locking in a fixed rate.

Final Thoughts

Choosing between fixed and variable ISAs isn’t just about today’s rates—it’s about where rates will go in the future. If you want certainty and don’t mind potentially missing out on extra earnings, a fixed ISA is for you. If you want to take a risk and ride the ups and downs of interest rates, a variable ISA might be more appealing.

Most importantly, don’t just look at today’s numbers—think long-term. Banks are always strategizing to make money, and understanding how they do it helps you stay one step ahead.

Using an ISA interest calculator can help you compare different options and ensure you’re getting the best deal for your savings.

John Michaels

Senior Writer & Contributor at ISA Interest Calculator

John is an experienced finance professional having been a financial advisor and city trader for over 15 years he attained his DIPFA in 2013 and has been advising millennial and Gen Z investors and savers on ISAs, investment portfolios and personal savings in the UK.