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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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