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Finance

What is a Variable Interest Rate?

Malcolm Tatum
By
Updated May 17, 2024
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As opposed to a fixed interest rate, the variable interest rate is a financing option that can allow a consumer to take advantage of current economic conditions to pay a lower rate of interest on a loan or mortgage. Because the variable interest rate is based on current averages on a national level, the general state of the economy can drive down interest rates for extended periods of time. During these periods, the consumer can save a substantial amount off the original or starting rate of interest associated with the transaction.

Variable interest rates do carry a greater degree of risk than going with a fixed rate. Because the fixed rate of interest will remain constant for the duration of the loan or mortgage, the investor knows how much he or she will pay in interest over the long term. With a variable interest rate, this is not the case. The investor may eventually pay much less interest than indicated at the time the contract went into effect and the completion of the terms. On the other hand, the average rate of interest may climb above the initially quoted rate. When this happens, the investor will pay much more in interest over the life of the mortgage or loan.

Federal treasuries often define the conditions that impact interest rates during a given period of time. The variable interest rate will be determined based on those findings and can impact a number of investments. Variable interest rates may be influenced by money market rates, a lender’s cost of funds, or a current index that is related to the type of loan that is extended to the investor.

One common application of a variable interest rate is to combine it with a fixed rate in what is known as an adjustable rate loan. Generally, this type of loan begins with a specified period of years in which the borrower is guaranteed a specific rate of interest. The rate remains the same regardless of general economic conditions. At the end of that period, the interest rate migrates from a fixed to a variable rate and is applied to any remaining balance due on the loan.

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Malcolm Tatum
By Malcolm Tatum , Writer
Malcolm Tatum, a former teleconferencing industry professional, followed his passion for trivia, research, and writing to become a full-time freelance writer. He has contributed articles to a variety of print and online publications, including WiseGeek, and his work has also been featured in poetry collections, devotional anthologies, and newspapers. When not writing, Malcolm enjoys collecting vinyl records, following minor league baseball, and cycling.
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Discussion Comments

By cupcake15 — On Oct 25, 2010

Sneakers41-The thing to keep in mind with annuities is that they are really a retirement product, so if you try to take your money back after the term is up, then you will be charged ordinary income tax, if you are under retirement age.

This is why when you enroll in an annuity you are leaving the funds in place long term. If you need money within a few years, this is not the right investment because you will have to pay surrender charges along with early withdrawal penalties.

A bank representative can call the insurance company and prepare a hypothetical for you to give you an idea of the type of money you will earn.

I always hear Suze Orman saying to stay away from variable annuities because once you start to invest in them, it is difficult to get out of them and they offer such paltry variable interest rates that you are better off investing that money in the market yourself and watch it grow instead of making money for the insurance company.

By sneakers41 — On Oct 25, 2010

Oasis11-FHA loans also have more liberal lending standards since the loans as backed by the federal government.

The only thing is that their interest rates are slightly higher, but they do offer loans with as little as 3% down payment.

I know that there are some people that like to invest in life insurance annuity. A life insurance annuity can either be a fixed or variable annuity interest rate that offers guaranteed payments for a specific timeframe.

For example, if you were to invest $75,000 in an annuity that was set for 7 years, you would have a fixed rate for the first two or three years and a variable rate thereafter. You would also be offered a guaranteed minimum interest rate for the remaining years.

The minimum interest rate might be something like 1.5% which is not much, but people generally invest in annuities because they offer a higher rate of return than cash products like CD’s and money market accounts.

By oasis11 — On Oct 25, 2010

SurfNturf- However, when the payments reset they can be 40% to even 50% of the current mortgage payments which is why this type of mortgage is only recommended for seasoned investors that are able to sell the property within that time frame, or have the necessary funds and time to rent out the property and wait for the market to turn.

Many people bought homes in this fashion and now are unable to make their mortgage payments which have led to the foreclosure crisis.

It is believed that one out of four homes is in foreclosure, which is a total of 25% of the market.

Once you go into to foreclosure it will take at least four years for a bank to allow you to obtain a mortgage.

For FHA loans the time frame for obtaining a loan after foreclosure is more like two years.

By surfNturf — On Oct 25, 2010

A standard variable interest rate is offered on home equity lines of credit and ARM loans or adjustable rate mortgages.

The adjustable rate mortgages work as a hybrid mortgage in which a portion of this interest rate loan is a variable rate interest and a portion of loan is at a fixed rate.

For example a 3 year ARM indicates a mortgage that has a fixed rate with three years, with an adjustable variable interest rate once or twice a year thereafter.

Many investors and new homeowners got these adjustable rate mortgages that reset so high that there aren't able to make the payments.

Traditionally adjustable rate mortgages like these offered below average interest rates for the first few years making mortgage payments affordable for people that normally would not qualify for such a high priced homes.

Malcolm Tatum

Malcolm Tatum

Writer

Malcolm Tatum, a former teleconferencing industry professional, followed his passion for trivia, research, and writing...
Learn more
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