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Variable Rate |
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Interest is the price paid by a money borrower for the use of a money lender's money. The original amount lent is knows as the principal, and the percentage of the principal which must be paid annually as interest is called the interest rate.
A loan featuring a variable rate interest means that the interest rate applied to a credit card or loan can fluctuate on a regular basis. Variable rate loans are tied to a prime rate. The current interest rate is whatever prime rate the issuing bank uses plus an extra percentage which is the banks profit margin. For example if the issuing bank using the Wall Street Journal prime, plus 5.9% and the WSJ prime is currently 4% the interest rate will be 9.9%.
Fluxations in the prime rates are primarily impacted by the prime rate set by the Federal Reserve, but they can also be affected by a number of other factors such as economic situation, various market performance, military conflict, unemployment levels, etc.
For money borrowers, there are several advantages for having variable rate interest over fixed rate interest. For instance, because variable rate interest can change regularly over time, it offers less security and stability to the money borrower, and also correspondingly less risk to the money lender. There lower levels of stability and security usually mean that variable rate interest is lower than fixed rate interest. In addition, when variable rate interest changes, it is usually in small increments separated by periods of time which are measured in weeks or months. Because of this, rises in variable rate interest tend to be small and spread out, allowing the borrower time to adjust and prepare for the higher interest payments.
For money borrowers, there can also be disadvantages for having variable rate interest. For example, as a result of recent interest rate hikes, they may end up paying far more interest than they would otherwise be paying if they had entered a credit agreement with a long period of fixed rate interest.
For money lenders, variable rate interest generally exposes them to lower risks than fixed rate interest, because when interest rates change, the variable rate interest also changes. That is, unlike fixed rate interest, a large gap cannot develop between the prevailing interest rate and the variable rate interest because the variable rate interest is not fixed for a period of time.
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Credit Card Definitions > N - Z > Variable Rate
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