Variable Rate
Definition
An interest rate on a loan or security that fluctuates over time, because it is based on an underlying benchmark interest rate or index.
Deep Dive
A variable rate refers to an interest rate on a loan, mortgage, or security that is not fixed for the entire term but instead fluctuates over time based on changes in an underlying benchmark interest rate or index. This dynamic pricing mechanism means that borrowers' payments or investors' returns can change periodically, typically monthly, quarterly, or annually, in response to movements in the specified reference rate. The variable rate is usually calculated as the sum of a publicly available benchmark, such as the Prime Rate, LIBOR (or its successor, SOFR), or a Treasury index, plus a fixed margin or spread determined at the time of origination.
Examples & Use Cases
- 1A homeowner with an Adjustable-Rate Mortgage (ARM) sees their monthly payment increase when the mortgage's benchmark index rate rises at the annual adjustment period.
- 2A small business secures a line of credit with an interest rate tied to the Prime Rate, meaning their borrowing cost will fluctuate with changes to the Prime Rate.
- 3A credit card's Annual Percentage Rate (APR) is advertised as variable, meaning it can change based on movements in the federal funds rate or another index.