Variable interest rate

Also called Floating rate, Adjustable rate

An interest rate that can change over time because it is tied to a benchmark index, so payments may rise or fall.

What it means

A variable rate is usually the sum of an index, such as the prime rate or another market benchmark, plus a fixed margin set by the lender. When the index moves, the rate follows at scheduled adjustment dates. Credit cards, HELOCs, adjustable-rate mortgages and many private student loans use variable rates.

Some variable-rate products limit how much the rate can change at each adjustment and over the life of the loan; these caps vary by product and lender. Savings accounts also pay variable rates, which banks can change at any time.

Example

Suppose a HELOC charges the prime rate plus 1 percentage point. If prime is 7%, your rate is 8%. If prime later rises to 8%, your rate becomes 9%, and the interest on a $20,000 balance rises from about $1,600 to about $1,800 a year.

How it’s used

Credit cards and home equity lines of credit
Adjustable-rate mortgages
Borrowing for a short time or when rates are expected to fall

Strengths and weaknesses

Strengths

Often starts lower than a comparable fixed rate
Payments can drop if market rates fall
Can suit short-term borrowing

Weaknesses

Payments can rise, sometimes sharply
Harder to budget over the long term
Terms like caps, margins and adjustment schedules can be complex

Good to know

Check what the payment would be at the highest rate the loan allows, not just the starting rate.

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.