A variable interest rate, otherwise known as a floating rate or adjustable rate, is an interest rate that may fluctuate over the course of the loan, credit card, or mortgage term. Whether the rate increases or decreases is based on the current financial markets.
What Is A Variable Rate?
Variable interest rate (or adjustable or floating interest rate) is an interest rate on a loan or credit card that changes. The variable interest rate changes over time because it is based on an underlying benchmark interest rate or index that changes periodically. This means that an array of factors can influence your interest rate. The most important factors are:
- The economy
- Stock market conditions
- International borrowings
- Fiscal deficit and government borrowing
At a first glance, it might seem complicated — but it isn’t. If the economy is strong, lending standards follow suit. This causes potential rises in interest rates. If there is a lot of international debt leading to fiscal deficit and inflation, interest rates will decrease. This will ultimately lower an individual’s ability to both buy and pay for goods.
These are the factors that influence the exact percentage of variable rate. Variable rate usually changes over three, six, or 12 months, depending on your deal and your lender. Variable interest rate normally changes based on a reference rate. The most common is the LIBOR — London Interbank Offered Rate. This anagram is what you should remember and pay attention to, since it represents the changing percentage.
Let’s say that you are taking the loan, and at the moment the LIBOR stands at 3%. Besides LIBOR, one more percentage depends on your lender. Let’s say that the terms of your loan, defined by the lender, for a 12-month period are equal to LIBOR plus an additional 3%. It means that you will pay the rate of 6% on your loan.
Since this is a variable rate, after the 12-month period LIBOR can change. If LIBOR decreases to 2%, you will pay 2+3%, instead of 3+3% as last year. Variable rates aren’t unusual. It’s quite the opposite. It is the standard in many countries worldwide. And, in the US, adjustable rate mortgage loans are much more common than fixed-rate loans.
Should I Take A Fixed Or Variable Interest Rate Loan?
The decision mostly depends on the specifications of your loan. You will also want to consider the current state of the economy.
You will want to both see historical LIBOR data and analyze the current situation. If LIBOR is currently low and has been that way for some time, then it can seem promising to opt for variable rate. Especially if you are taking a relatively small loan.
It is more secure to take out a loan with a static rate. That way you will avoid any potential rate changes that could affect your loan conditions. These changes could be positive, but may also prove very costly in terms of interest.
If you believe that you can avoid high interest by taking an adjustable rate, your decision should be based on the facts. If you prefer security and transparency, it’s better to keep things simple and opt for the fixed rate.
What Should I Do When Considering A Variable Rate Loan?
Even though you cannot influence LIBOR, you can inform yourself. That way it will be easier to decide whether to opt for a fixed rate or adjustable rate.
First, figure out your expenses. Now, with expenses in mind, decide which interest rate option best suits your goals and then decide whether to opt for a fixed or variable rate.
When taking out a loan you should discuss all the details with your lender. Visit our FAQ and blog to inform yourself of all options. Remember that both rates have two parts: LIBOR (which you can’t change) and percentage that you agree to, set by your lender.
If you opt for a fixed rate loan, you’ll have the same interest percentage the whole repayment period. But, if you opt for an adjustable rate, your rate percentage will vary periodically — potentially going down, lowering your rate.
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