What is a variable rate?
A variable rate, or variable interest rate, is the amount charged to a borrower for a loan, such as a mortgage. A variable rate is usually expressed as an annual percentage and fluctuates in tandem with a rate index.
A variable rate on a mortgage changes throughout the loan term. As the interest rate changes, the borrower’s monthly payment changes. A variable rate is the opposite of a fixed rate, which remains the same for the term of the loan.
Lenders and borrowers come to an agreement on the terms of a loan, including the variable rate. This includes defining which index the loan will be tied to, how often the rate can change, and the maximum allowable increase per rate change.
A variable interest rate is based on a benchmark rate or index, such as the prime rate published by The Wall Street Journal. When that index rises or falls, it affects the interest rate paid by the borrower. The benefit of a variable rate is that as it drops, so does the borrower’s interest payment. Some variable-rate loans, however, have terms that limit rate drops.
A variable-rate mortgage loan typically offers a lower annual percentage rate, or APR, initially, to encourage borrowers to sign up for the loan. The same is true for variable-rate credit cards and personal loans.
Example of variable rate
Kevin obtains a mortgage loan at a time when interest rates are falling. He has the choice between a conventional fixed-rate mortgage at 4.1 percent and a 5/1 ARM at 3.55 percent. With the 5/1 ARM, Kevin’s interest rate will stay the same for the first five years, then adjust annually. Kevin’s variable rate is tied to the Treasury index. Kevin does not plan to stay in his house for more than five years, so the 5/1 ARM works to his benefit.
Keep up to date on mortgage rates for variable- and fixed-rate loans using Bankrate’s mortgage rate tool.