What is Variable Rate Loan? | Read Meaning, Benefits and How it Works


What is Variable Rate Loan? - Online Definition

Variable rate or floating rate loan is a special category of loan wherein the applicable interest rates change depending on the changes in market interest rates. For traditional fixed-rate loans, a constant interest rate is maintained throughout the loan tenure. However, in the case of variable rate loans, the lending institution offers its borrowers improved potential for savings as well as increased profits based on the market situation.

This allows borrowers to benefit from low-interest rates provided by financial institutions, saving a considerable sum of money. Variable interest loans provide more flexibility with the interest payments, showcasing a great potential for savings if there is a decline in the market rate (like the repo rate). Moreover, variable interest rates could be lower than fixed rates prevailing in the market.

KEY TAKEAWAYS

  • A variable rate loan is a loan where the borrower does not have to pay a fixed interest amount. As the interest rate changes depending on market conditions, the borrower may pay the relevant interest amount accordingly.
  • As variable-rate loans provide more flexibility with interest payments, the borrower has great potential for savings.
  • Potential borrowers must analyse their personal risk tolerance before opting for this loan as a hike in the interest rates may prove to be a financial burden.

How Variable Rate Loans Work?

The variable rate loan is based on a reference rate or benchmark index. In India, interest rates of variable loans are linked to the repo rate of the Reserve Bank of India (RBI). This is the interest rate at which banks borrow money from RBI and it acts as the reference point for auto loan, mortgage, and credit card rates decided by lenders. As and when the underlying benchmark changes, the interest rate also changes.

Benefits of Variable Rate Loans

Here are some of the major benefits of variable rate loans you will unlock:

  • The borrower’s perspective on a variable rate loan is usually lower at the beginning of the loan tenure.
  • Enable applicants to clear the principal amount quicker, saving on interest costs overall.
  • The variable rate loans are ideal for short-term financial requirements.

Final word

Variable interest rate changes according to altering market conditions or a specified benchmark/reference point. Even though initially the interest rates may be lower than the fixed-rate loans, the amount may increase over time. However, under better circumstances, they may also decrease over a particular period.

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