Variable Rate Loans

A variable rate loan is a type of loan that has a fluctuating interest rate based on the current financial markets.This can allow borrowers to potentially benefit from lower rates and a reduced monthly payment. However, it’s important to consider the risks involved, as variable rate loans come with the possibility of interest rate increases and higher payments as well. 

Many Americans opt for a variable loan interest rate when given the opportunity. In fact, 40% of Americans say they would consider a variable rate mortgage.1 Here, we will explore how variable rate loans work, how they compare to fixed rate loans, and what your other financial alternatives are. 

What Is a Variable Rate Loan?

While a fixed interest rate loan has the same rate throughout the repayment process, the rate for a variable rate loan changes, hence the name. This type of funding may provide potential savings on interest payments. However, it’s also important to note that loan interest rates may also increase some months, depending on market conditions. 

When it comes to repayment, borrowers repay their balance in monthly installments over a predetermined period of time, which may vary depending on which lender you go with. 

Advantages of Variable Rate Loans

The primary advantage of variable interest rate loans is their potential to save money while paying back a loan. This flexibility and potential for cost savings are what make variable or adjustable interest rate loans so attractive to many borrowers. 

When financial markets are doing well, those with a variable interest rate will often enjoy a lower monthly payment, thereby enhancing their financial flexibility and freeing up funds for other uses, allowing borrowers to pay off debt and still save money. 

Disadvantages of Variable Rate Loans 

While variable interest rate loans offer potential savings, they come with the risk of rising interest rates resulting in increased monthly payments. The fluctuating nature of these variable loans can make budgeting a challenge, as payment amounts could vary from month to month. 

Finally, in the event of an upward trend in the economy, it is possible that you will end up paying a higher amount of interest over the duration of the loan as compared to a loan with fixed interest rates.

How Do Variable Interest Rate Loans Work?

Before applying for a variable or adjustable interest rate loan, start by researching lenders and comparing their rates and terms. After you have found a lender you think will be a good fit, go ahead and submit an application. The application will typically ask for basic information like your name, address, income, and desired loan amount. 

You can usually expect a credit check to take place during the application process so lenders can get more insight into your financial history and confirm you are not currently going through the bankruptcy process. If approved, review the loan offer, sign the agreement, and receive the loan funds. 

Alternative Personal Loan Options

If a variable interest rate seems risky, consider alternatives like a fixed rate loan. Fixed rate loans offer predictable monthly payments, which remain constant throughout the loan term, regardless of market fluctuations. Other alternative loan options include: 

• Secured Loans: Funding that requires collateral, such as an auto title loan. 
• Unsecured Loans: Funding that does not require collateral, like many personal loans. 
• Payday Loans: Short-term, high-rate funding designed for extreme financial emergencies. 

Installment Loans: Funding paid off in monthly increments, similar to a personal loan.

Variable Rate Loan vs. Fixed Interest Rate Loan

Types of Variable Rate Loans

Variable interest rates are not unique to a specific kind of loan. They can be associated with:

• Mortgage Loans: Funding used to purchase real estate, typically a home for the borrower. Mortgage rates usually vary, depending on the borrower’s credit score, income, property value, etc. 
• Home Equity Lines of Credit: A credit line where the limit is calculated based on the equity in the borrower’s collateral. 
• Auto Loans: Funding used to purchase a vehicle. 
• Credit Cards: Revolving lines of credit that typically do not require collateral. 
• Personal Loans: A versatile form of funding best suited for financial emergencies. 
• Student Loans: Funding used to pay for higher education, usually at a college or university. 

What Impacts Variable Rate Loans?

Key factors influencing your interest rate include inflation rates, economic growth indicators, changes in economic activity and monetary policies set by central banks. 

For example, during the Covid-19 pandemic, the Federal Reserve assisted in pushing interest rates for mortgages below 3%. The purpose of this drop was to stimulate the market and encourage borrowers to purchase real estate and take out mortgages.

Also, the borrower’s creditworthiness and the lender’s specific terms and conditions can also affect the interest rate on variable rate loans. Other factors that can go into the decision making process for loan rates are federal regulations and state-specific laws. 

Variable Rate Loan Calculations

Interest rates for variable rate loans are calculated using several factors, including: 

• Annual percentage rate (APR). 
• Loan term. 
• Current market conditions. 

Understanding the factors that go into determining your interest rates can help you decide whether a specific loan type may be right for you or not.