How Variable Rate Loans Work

Variable Rate Loans are loans in which the interest rate is not fixed. The rate fluctuates based on an index such as money market rates or the bank prime rate.

With these loans the monthly payments are sometimes a fixed amount that doesn’t change. Some examples are automobile loans, unsecured personal loans and home equity lines of credit.

The interest rates are adjusted at various times over the life of the loan. The adjustment schedule will be included in your loan documents and should be explained to you by your banker.

When the loan is issued, your payments are figured and the loan is amortized based on the interest rate at that time. If the interest rate didn’t change at all, you would pay off the loan on schedule.

However, this probably won’t happen. If the rates go lower than they were when the loan was issued, you will pay off your loan early. But if the rates go higher, you will end up with a balloon payment at the end.

This payment could be a little or a lot depending on how much the interest rate changed during the loan.

Often the loan documents will state that you will be able to extend your loan rather than having to make the entire balloon payment at once. Make sure to discuss this with your banker before signing anything so there won’t be any unpleasant surprises at the end.

Depending on the type of loan you have, you may can re-finance if interest rates drop really low. If you are able to get a fixed rate loan, you could lock in those low interest rates for the remainder of the loan.

From Variable Rate Loans to Banking Information