Variable interest rate is the opposite of fixed interest rate. While fixed interest rate stays the same for years, variable rates keep fluctuating. These kinds of loans are unpredictable because the changes are triggered by various economic situations. The price of loans subjected to variable interest rates can increase or decrease with time.
Borrowers prefer variable interest rates because they harbor the hope that the rate will decline in the future. This kind of interest rate only works best for a short term loan as you can’t predict the market situation over a long term.
Types of Variable Interest Rates
Variable interest rates apply for many types of loans, including credit card loans, mortgage, or student loans.
1. Adjustable Interest Rate Mortgage
One type is the adjustable-rate mortgages that lock your starting rate for a given period then implement a variable rate after some time. This method mostly works on mortgage loans. The loans are also subject to adjustment caps that limit how the rate fluctuates and the specific adjustment periods.
Variable rates on student loans or credit cards are expected to start changing right away and adjust often. These rates can change without any prior notice to the borrower. The variable rates on a credit card can change to respond to some indexes, such as the prime rate.
Why Variable Interest Rate Matters
Interest rate fluctuations are triggered by various things, such as consumer spending and business inventories. There is no single entity that sets interest rates because every bank has its own determination on how much they’re willing to pay and charge for their loans. The interest rates rely on the rule of demand and supply.
The rates matter because they influence the economy, and central banks take a keen interest in monitoring its behavior. The rates also affect daily consumer behaviors. It can help a consumer decide whether it’s a good time to invest, buy a house, and whether to borrow more or less. When the interest rates go high, there is less borrowing, and when it lowers, consumers borrow more. Interest rates also affect stock prices, investor’s future, and bond markets.
Limitation of Variable Interest Rates
Taking a loan on variable interest rate terms can affect your repayment ability if the rates rise and you cannot afford the loan. It’s important to understand the terms and review all the documents carefully because the rates can adjust anytime and affect your financial capabilities. Make sure you can still afford to finance the loan even with the highest possible interest rates.
Variable interest rates can be the best option if you’re considering a short term loan. However, if it’s taken for a long term, the repayment cost can increase beyond your expectations. This makes variable interest rates some of the riskiest loans.
Whenever you take variable interest rates either for credit card or mortgage, prepare for the interest rate fluctuations and most probably expect them to go up.