What is a Variable Interest Rate?

Published by Thomas Herold in Banking, Laws & Regulations

'Variable Interest Rate' is explained in detail and with examples in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Variable Interest Rate refers to the applicable interest rate which comes with a security or loan. When such rates are variable, it means that they will fluctuate up or down in time. The reason for this is that a specific index or interest rate benchmark underlies them. This rate or index will change from time to time in the natural course of events. There is a potential great benefit to having such a variable interest rate when this index or interest rate goes down. This is because the interest payments of the borrowers will similarly decline. On the other hand though, when such underlying benchmarks go up, the interest payments will also rise, sometimes painfully.

Not every loan, mortgage, or security will utilize the same benchmark index or interest rate as its underlying comparison point with these Variable Interest Rates. In fact it actually comes down to the kind of security or loan in question. With credit cards, car loans, or mortgages, the Variable Interest Rates are often based on the prime rate for the nation in which the loan is based. Naturally the financial institutions, lenders, and banks will assess a spread between their rate and the true benchmark rate. The amount of this spread form of fee depends on many factors. Some of these are the credit rating of the individual getting the loan and the kind of asset to which the loan is attached.

Where credit cards are concerned, most of them work on a Variable Interest Rate arrangement. Their APR annual percentage rate happens to be fixed to a specific interest index. In most cases, this is the prime rate. With the prime rate, it generally moves up or down in lockstep alongside the federal funds rate that the United States Federal Reserve sets as part of their fiscal and monetary policy tools. A move up or down in this rate eventually leads to a net change in the underlying interest rate of credit cards across America. Such rates for these credit cards working off of variable interest rates are able to shift up or down at will. The credit card companies are not even required to provide written or verbal advance notice to their cardholding customers before adjusting the rates when the benchmark moves.

In the accompanying terms and conditions of such credit card accounts, the applicable interest rates will generally be described as the underlying prime rate added to a certain percentage rate. This specified additional percentage is always heavily based upon how credit worthy the card holding individual proves to be. As a real world example, many cards will assess an interest rate addition of 10.9 percent on top of the prime rate to come up with their credit card customer interest rates.

With other forms of loans that have Variable Interest Rates, the payment schedule proves to be different. The majority of non-credit card forms of loans are actually installment loans. These payments to repay them are fixed and pre-arranged. This leads to the loan reaching pay off on a pre-set specified day. All that changes as interest rates rise or fall is the amount of the payment. This will similarly increase or decrease per the amount of the interest rate change as well as the numbers of payments that remain to fully pay off the loan.

Mortgages have their own specific features. When they carry Variable Interest Rates, such loans are known as ARM adjustable rate mortgages. A great number of such ARMs actually begin their repayment life with a fixed lower interest rate during the initial years of the loan life. Once this pre-determined time frame expires, they will adjust up, sometimes steeply. The most typical periods of fixed interest rates on these adjustable rate mortgages turn out to be either three or five years. Loan officers refer to this as 5/1 or 3/1 ARMs.

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The term 'Variable Interest Rate' is included in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.