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Variable Rate

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A variable rate is an interest rate that may fluctuate over time. To determine its variable rate, a lender first chooses an interest rate such as the prime rate, the 1-, 3-, or 6-month Treasury bill rate, or the fed funds rate as an index to which the variable rate will be tied. Next the lender adds a certain number of percentage points (called a margin, which varies from borrower-to-borrower depending in part on credit standing) on to the index rate, and that sum is the variable rate. Some lenders multiply the index or the index plus the margin by a set number to generate the variable rate. Opposite to a fixed rate, a variable rate should be lower initially than a fixed rate because of the interest-rate risk inherent in a variable rate (the risk is that a variable rate can increase). Examples of loans that typically carry a variable rate include credit cards, adjustable rate mortgages, and home equity lines of credit.

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