Single Variable Interest Rate Definition
Interest rates describe the costs of money. Interest rates are dynamic, and shift according to the economy. Lenders and borrowers use variable rates as a means to manage fluctuating interest rate environments.
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Identification
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Interest rates are categorized as either fixed or variable. Fixed interest rate loans charge the same level of interest throughout maturity. Variable interest rates adjust during the course of the loan--according to prevailing interest rates.
Features
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Variable interest rates may be pegged to one particular index. Typical reference points for variable interest rates include the federal funds rate, interest upon Treasury bills and the London Interbank Offered Rate (LIBOR).
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Considerations
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The Federal Reserve Board manages the economy through monetary policy. The Fed uses monetary policy to lower interest rates to promote growth. Conversely, the Fed influences interest rates higher to slow down the economy and guard against inflation.
Benefits
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Variable interest rates are ideal for borrowers that anticipate lower interest rates. Meanwhile, creditors that extend variable-rate loans earn higher payments when interest rates increase.
Risks
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Borrowers and the economy are at risk when interest rates move higher. Rising interest rates make variable loan payments more expensive. Further, consumers are less likely to take out loans to purchase goods and make investments.
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References
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