Fixing Variable Interest Rates

December 16, 2020 | by Jacob Hamilton

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A variable interest rate is, as its name suggests, one that varies over time. It goes up and down depending on a base rate of some kind. These interest rates offer pros and cons, and whether a variable interest rate is the right choice for you depends on your financial situation and the state of the overall economy. Find out more below.

How Do Variable Interest Rates Work?

A variable rate is tied to a specific index or base rate. When that base rate goes up or down, so does the variable rate on your loan.

What your rate is based on depends on the type of credit or loan you’re dealing with. Often, it’s based on a market index or the prime rate for the nation. However, it’s important to realize that the variable rate is not the same as the rate it’s based on.

Banks and other lenders use the base rate as only one factor in determining your actual interest rate. Your credit history and financial situation also come into play. Someone with a poor credit history might have a variable APR (annual percentage rate) that’s based on the prime rate plus a certain amount of points or percent. Someone with excellent credit might have a variable rate that’s based on the prime rate but with fewer points added to it.

The federal Truth in Lending Act does provide some requirements on the part of lenders to disclose the cost of credit. That includes disclosing APR and the total cost of financing in dollar amounts.

However, if you have a variable APR, your total cost could rise or fall with changes to the rate. In this case, the Truth in Lending Act does require that creditors note that financing costs are subject to change. They must also provide at least one hypothetical example that shows how those changes can impact costs so the consumer can make a more educated decision.

In some cases, lenders must also include a maximum variable interest rate—in such cases, you can’t be charged more than the upper limit. This can help you budget knowing what the max you might pay is.

Credit Cards

If you have a variable rate credit card, the interest you pay goes up and down according to the base rate. Look at your credit card documentation. If you see something that says your interest rate is “prime rate plus 9.99 percent”—or anything following a similar formula—you have a variable APR.

So, in the example above, if the prime rate is currently 3.1 percent, your interest rate would be 13.09 percent. If the prime rate rises to 4.01 percent, your interest rate would be 14 percent.

The impact to your account is that you accrue more or less interest on your balances depending on what happens with the base rate.

Loans and Mortgages

Variable rates work similarly with installment loans, but the impact to you can be slightly different. That’s because with a loan, you typically agree to pay off the total balance within a certain number of years or months.

If your interest rate changes, that can decrease or increase how much total you have to pay on the loan—but you still have to pay it off within the same amount of time. Because of that, a change in your variable interest rate can change how much your monthly mortgage or loan payment is.

What Are Interest Rate Caps?

An interest rate cap limits how high a variable interest rate can actually go. While caps can be used in all types of lending agreements, they’re most popular on adjustable-rate mortgages.

The Consumer Financial Protection Bureau (CFPB) lists three types of caps. There’s the initial cap, which limits how much interest can rise the first time it’s adjusted. Subsequent adjustment caps limit how much interest can rise each time in the future—they’re meant to help create reasonable stair-stepping in interest rates so a consumer isn’t surprised by a sudden enormous jump.

A lifetime adjustment cap sets how high interest can go overall. This would be how high total interest can rise before it maxes out on your loan. With mortgages, the CFPB notes that a common lifetime cap is 5 percent higher than the initial interest rate.

Variable Rate vs. Fixed Rate

Variable rates are contrasted with fixed rates. Fixed rates remain the same over the life of the loan or account unless you refinance or ask for a review to see if you qualify for a lower rate.

The benefit of a fixed rate is that your loan payments and interest expense are set. You can take them to the bank—literally and figuratively—and budget easily for them. The downside is that they stay the same, even if the market changes in your favor.

The benefit of a variable rate is that it changes according to the market. So, if you take out a loan when market rates are high but think those rates will drop in the near future, you can potentially save money on the interest rate. The downside is that the opposite is also true. If market rates rise, you may be on the hook for a bigger expense and loan payment.

Can You Change Your Variable Rate to a Fixed Rate?

The Truth in Lending Act notes that if you have an option to convert a variable rate to a fixed rate, that option must be disclosed in your loan paperwork. Unless this is a specific option spelled out in the paperwork, you can’t usually convert easily.

However, if you decide that a fixed-rate mortgage would be better for you during the life of the loan, you might be able to refinance. This is especially true with home loans, though your ability to refinance depends on your current credit score and history as well as other factors, such as the value of the home and your income.

You typically can’t change terms on your credit card from variable to fixed rate. However, if your credit has substantially improved and you’re a cardholder in good standing, you might be able to talk to your credit card lenders about a lower interest rate. Certain loans, such as federal student loans, only offered fixed interest rate options.

Choose the Best Option for You

It’s important to know the terms of all your credit accounts, including what interest rate you have. You need to know how much you’re paying for your credit and whether that amount might fluctuate. You’ll also want to ensure you can make payments no matter what they are to avoid negatively impacting your credit.

The best option for you really depends on your specific circumstances. If you have a tight monthly budget, for example, and need to know that your mortgage payment will never go above a certain amount, a fixed option is likely better. However, if you have extra income and can deal with a higher mortgage payment in the near future, a variable rate mortgage could help you save money over the life of the loan if rates drop further down the line.

You need to protect your credit history and score regardless of whether you opt for fixed or variable interest rates. If your score is lackluster due to inaccurate or unverified negative items, consider working with to help your score with credit repair services before you apply for any type of loan.

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Jacob Hamilton


With his master's degree from the University of Phoenix, Jacob has been working as the General Manager for for 2 years. Jacob is passionate about consumer finances and doing everything he can to make credit repair accessible....

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