What Is a Variable Rate Loan?
Variable rate loans are lines of credit or closed-end credit accounts that offer interest rates that can fluctuate. Different from fixed-loan rates, variable rate loans are often tied to certain market indexes that adjust based on economic conditions. There are several types of variable rate loans.
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Identification
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Any loan that has a variable rate---mortgage, credit card, line of credit---must disclose the features of that rate before the borrower agrees to the account. This can be handled when reviewing the loan agreement or can be disclosed on a piece of paperwork sent to the borrower---which is often the manner in which it is disclosed for credit cards.
How It Works
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Variable rates can adjust based on the guidelines in the credit agreement. Most variable rate mortgages begin as a fixed rate for a predetermined period of time. After that period of time, the rate can adjust on a periodic schedule---monthly, bi-weekly, annually---for the remainder of the loan. Variable credit card rates often can adjust at the will of the lender---especially depending on payment history.
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HELOCs
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HELOCs, or home equity lines of credit, are often variable rate loans tied to national indexes. These indexes include the LIBOR, Prime Rate, and the 12-month T-Bill (Treasury Bill) rate. These rates are published daily in "The Wall Street Journal." Based on the way in which the rate is tied to the index, it will adjust with the market. For example, in a down market, national indexes may adjust down to increase lending---thereby lowering the rate on a variable rate loan.
ARM Loans
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ARM loans, or adjustable rate mortgage loans, are home loans that are tied to an index (see above). Adjustable rate loans often start with a fixed rate, and then the rate on the loan is figured by adding the margin and index on the loan together. The margin is a fixed rate connected to the mortgage loan, and the index is the adjusting rate.
Warning
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Variable rate loans can be beneficial based on economic conditions. However, with variable rate mortgage loans, even small adjustments in the rate will significantly affect the monthly mortgage payment. Consumers considering variable rate loans should view them as short-term solutions.
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