What are loan variables?

Answer 1

A variable-rate loan is a loan for which the rate of interest varies

periodically with a changing market rate,

such as the prime rate.

With a variable-rate loan, the periodic rate fluctuates along with a predetermined measure, such as the prime rate or the Treasury bill (T-bill) rate. The prime rate is

the rate banks charge to their most preferred customers, and it is commonly

used as a base rate for variable-rate loans.

For example, suppose you took out a loan in February 2004, when the prime

rate was 4 percent, and agreed to pay the prime rate plus 2 percentage points

in interest. The interest rate on your loan would have started out at 6 percent,

but you took the risk of unexpected increases in future payments. For example,

by October 2006, the prime rate had more than doubled, to 8.25 percent, so

your loan rate increased to 10.25 percent, resulting in a substantial increase your monthly payment. In periods when interest rates are rising, especially when they rise rapidly, a variable-rate loan can subject you to unexpected increases in required payments. However, variable-rate loans generally carry lower initial interest rates than fixed-rate loans because the lender isn't facing the risk of having the interest rate fall behind market rates on comparable loans. Therefore, if the introductory rate is low enough, or if you don't expect to borrow the money for a long period of time, you might find it worthwhile to take out a variable-rate loan, despite the risk of increased payments.

Certain types of loans are more likely than others to have fixed rates. It's relatively common for rates on automobile loans to be fixed, whereas rates on home equity loans can be either fixed or variable. The interest rates on credit cards can be either fixed or variable. In practice, revolving credit agreements are most often classified as variable-rate loans because the issuer generally retains the right to change the rate at any time in the future.