Variable-Rate Loan
A variable-rate loan, also called an adjustable-rate or floating-interest loan, is a type of financing where the interest rate is tied to a benchmark index, such as the prime rate or LIBOR, plus a margin set by the lender. Unlike fixed-rate loans, the rate and monthly payments on a variable loan can increase or decrease throughout the term.
For consumers, variable-rate loans may initially offer lower interest rates compared to fixed loans, making them attractive in the short term. However, they carry the risk of rising payments if market rates increase.
This unpredictability can create budgeting challenges and financial stress over the long term. For lenders, variable-rate loans reduce interest rate risk, as they can adjust rates in response to market changes.
For borrowers, these loans may work best if they plan to pay off the loan quickly or expect rates to remain stable. In auto financing, variable-rate loans are less common than fixed-rate loans but are sometimes used in special promotions or with certain lenders.
Ultimately, variable-rate loans illustrate the trade-off between short-term savings and long-term uncertainty, requiring borrowers to carefully weigh risks before committing.
Example
When Sam finances his car with a variable-rate loan starting at 3% APR, his payments are initially low. Two years later, interest rates rise, and his payment increases by $45 per month, impacting his budget.