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Variable rate

Variable rate is a financial term every borrower should understand. Bankrate explains it.

What is a variable rate?

A variable rate, or variable interest rate, is the amount charged to a borrower for a variable-rate loan, such as a mortgage. A variable rate is usually expressed as an annual percentage and fluctuates in tandem with a rate index.

Deeper definition

Borrowers agree on the terms and conditions of a loan, including the rate at which interest accrues. Interest could accrue at a fixed rate, meaning that it’s always the same percentage throughout the life of the loan. Or interest may accrue at a variable rate, and could go up or down throughout the loan term.

As the interest rate changes, the borrower’s monthly payment changes. Other terms of the loan include 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.

Initially, a variable-rate mortgage loan typically offers a lower annual percentage rate, or APR, to encourage borrowers to sign up for the loan. The same is true for variable-rate credit cards and personal loans.

Keep up to date on mortgage rates for variable- and fixed-rate loans using Bankrate’s mortgage rate tool.

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.

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