Definition of Variable Interest Rates
Lenders advancing funds to borrowers assess interest rates on principal as investment costs while foregoing direct investment opportunities. Rates are computed as an annual percentage of principal, with rates determined by the life of the loan, borrower's credit risk and the inflation rate. Interest rates loans are fixed or variable, and used for personal and commercial loans.
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History
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Interest at one time was negatively perceived. The Law of Moses forbade charging interest in ancient biblical Israel. Time was considered God's property during the middle ages and therefore God's commerce. Catholic theologian, Thomas Aquinas, considered termed interest as "double charging". The church deemed this as sin of usury. The Renaissance era improved mobility facilitated increased commerce and entrepreneurial conditions. Loans were no longer for consumption, but production too. Interest became viewed as a paid premium to lenders assuming risk and opportunity cost.
Features
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Variable interest rates fluctuate with underlying interest index changes. In declining interest rate markets, variable rates fall in conjunction with the underlying interest index. Are you risk-oriented and believe that average interest rates over the entirety of the loan may go down? A variable interest rate loan may be a good loan option for you. The benefit being if interest rates go down during the life of the loan, you save money in the long run.
Fixed interest rate loans have set interest rates for entire loan terms, regardless of interest index performance. Interest rate environments and loan durations determine which loans are better choices for borrowers. Fixed rate loan terms are done at the then prevailing market interest rate, plus or minus a spread unique to the borrower.
Considerations
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Carefully consider loan amortization periods when choosing between variable and fixed rate loans. Longer loan amortization period's means greater interest rate changes, which will positively or negatively impact loan payments. If unable to stomach possible, and probable, periods of higher loan payments due to interest rate fluctuations, then fixed rate loans are a better choice for peace of mind. Relatively low interest rates about to rise are also better locked in at fixed rates.
Function
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Some variable interest rate loans are hybrids with fixed rate elements. Caps are set in place so that interest rate jumps go up only so much within certain time frames, limiting payment shock. Furthermore, some hybrid variable loans put ceilings on how high your interest rate will increase with the underlying interest rate market index.
Warning
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There is no reliable way to predict future interest rates. Can you tolerate monthly payment fluctuations? If yes, a variable interest rate loan may be the right loan vehicle for you. Interest rates on variable interest rate loans change either monthly or quarterly, depending on the lender. Your payments will change accordingly. If no, consider a fixed interest rate. Fixed interest rates mean fixed monthly payments for the life of the loan. The predictability of this loan type can help you manage your money.
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