Variable Interest Rate

An interest rate on a loan or security that fluctuates over time, because it is based on an underlying benchmark interest rate or index that changes periodically. The obvious advantage of a variable interest rate is that if the underlying interest rate or index declines, the borrower's interest payments also fall. Conversely, if the underlying index rises, interest payments increase.

The underlying benchmark interest rate or index for a variable interest rate depends on the type of loan or security. Variable interest rates for mortgages, automobiles and credit cards may be based on a benchmark rate such as the prime rate in a country. Banks and financial institutions charge consumers a spread over this benchmark rate, with the spread depending on a number of factors such as the type of asset and the consumer's credit rating.

For variable interest rate bonds, the benchmark rate may be the London Interbank Offered Rate (LIBOR). Some variable rate bonds also use the five-year, 10-year or 30-year U.S. Treasury bond yield as the benchmark interest rate, offering a coupon rate that is set at a certain spread above the yield on U.S. Treasuries.