What is a Variable Interest Rate and its Pros and Cons

In modern day banking, loans and mortgage accounts can be classified into fixed and variable interest rate accounts. While both have their own pros and cons, many experts propose to use variable interest rate accounts instead of choosing fixed interest rate accounts as the latter requires paying a relatively higher interest rate at the beginning of the repayment and pay a much bigger total amount at the end of the term. However, making a decision between the two could be rather difficult, as the outcome would depend much on the market status prevailing within a particular period. Thus, this article will provide you with a brief description about what variable interest rate accounts are and the pros and cons associated with the same.

What is a variable interest rate?

When the interest rate assigned to a loan or a mortgage account fluctuates based on the market fluctuations of interest rates, it is called a variable interest rate. Thus, during the term of the account, its interest rate would not remain the same as it was in the beginning, but instead will change from time to time. However, depending on the market, there is a possibility of interest rates going down or even going up. Therefore, unless the economies behave in a predictable manner, it is rather difficult to guarantee or predict how the interest rates will fluctuate in the future.

What are the pros of having a variable interest rate?

If the market interest rates fall during the term of the account, the proportion of the principle paid at the beginning could be more when considering the same duration when the interest rates were fixed. This means that the total interest that has to be paid at the end of the term would be less in variable interest accounts than when the interest rates are fixed in the event of falling interest rates. It also means that the duration which takes to complete the loan or the mortgage in full could become shorter when the interest rates fall.

What are the cons of obtaining a variable interest rate account?

The downside of obtaining a variable interest rate account is when the market interest rates rise beyond the initial interest rate, the account holder will end up paying a higher interest rate and therefore much of the repayments will be towards settling the interest at the beginning. This means that there will be more of the principle to be repaid at the end of a term and therefore the amount and the length of the total payment could become more than what was initially expected. At the same time, it is rather difficult to predict or budget the repayments in such accounts and that could make repayment difficult in the event of a rising interest rate.