What Is a Variable Interest Rate? A Comparison with Fixed Rates

A variable interest rate means that the interest rate changes. Also called an adjustable rate or floating rate, it refers to cases where the interest changes over the term of a loan or deposit. This is the opposite of a fixed rate, where the interest rate does not change. Variable rates are usually applied to loans such as secured loans, but they can also apply when you use a credit card.

Understanding Loans and Interest Rates

Loans usually come with either a fixed or a variable rate. Small loans often have fixed rates, but loans repaid over several years or even decades, such as mortgages, are often signed with variable rates. With a fixed rate, the rate does not change during the loan term. With a variable or adjustable rate, the rate is adjusted periodically according to market conditions.

For example, if someone takes out a loan at a fixed rate of 4%, they will keep paying interest at that same rate for the entire repayment period. On the other hand, if they take out a loan at a variable rate, the rate may start at 4% and then go up or down. As a result, they may have to repay a different amount every month.

Why Interest Rates Go Up and Down

Interest rates are heavily influenced by the money supply. An increase in the money supply means that lenders everywhere are trying to lend money, and people will borrow from whoever offers the cheapest interest. In other words, when the money supply increases, interest rates go down. Conversely, if the money supply shrinks, borrowing money becomes harder, and people will have to pay higher interest to borrow funds.

So how is this all-important money supply controlled? The answer is banks. In Korea, the Bank of Korea is the central bank. The Bank of Korea supplies money to commercial banks, and commercial banks use it to make loans in the market.

In the United States, the Federal Reserve plays the same central bank role as the Bank of Korea. Because the Fed has the authority to issue dollars, it controls the circulation of dollars across the US by supplying and absorbing them. When the economy is doing poorly, rates need to come down, so it prints more dollars (quantitative easing). In the opposite case, it reduces the supply or pulls back money it had supplied, raising interest rates.

Variable vs. Fixed Rates: Pros and Cons

Variable-rate loans often have lower initial rates than fixed-rate loans. This can make them attractive to borrowers who don't have much repayment capacity at the start. A variable rate can also be a good choice for people who plan to sell the asset (such as a home bought with the loan) or pay off the loan before the rate is adjusted, or for those who expect the value of assets like real estate to rise quickly.

Another advantage is that rates may fall further, so you could end up paying less each month. However, the downside of a variable rate is that rates may rise, and you could end up paying more each month.

So you can't say for certain that either a variable or a fixed rate is always better. It's something each person has to judge based on their own loan, how they use the funds, and market conditions. If market rates are expected to rise, it would be better to lock in a fixed rate when taking out the loan, and if rates are expected to fall in the future, taking out the loan at a fixed rate would be more beneficial.