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How Variable Interest Rates Work

Variable interest rates are always related to the Bank of England base rate, which is the interest rate that is set by the Bank of England every month. Because the Bank of Engla...
Views: 2.162 Created 11/22/2006

Variable interest rates are always related to the Bank of England base rate, which is the interest rate that is set by the Bank of England every month. Because the Bank of England base rates will rise and fall periodically, repayment costs of loans based upon these rates will also rise and fall over the years. Variable interest rates can save you a lot of money at times because they benefit from rate reductions, but they may also cause you to have to pay higher rates at other times because they have no protection at all from rate increases.

Rarity of variable rates

You will find most loans that you apply for come with variable interest rates, either utilizing the rate fluctuations to offer lower rates now or offering attractive low introductory rates that will become variable after a set period of time. Despite how common various forms of variable rates are, most rates differ from one lender to another? each tends to have its own rate structure based upon the base rate, though it may be either significantly higher or significantly lower than other lenders in direct competition.

Advantages of variable interest rates

The advantages to variable interest rates are best seen when market rates go down. Then you'll pay less interest for that month. You have the opportunity to pay off your loan faster by just maintaining your constant repayment rate, even when the interest has gone down on the amount due. Many lenders will let you pay lump sum repayments at any time, too, so if you're worried interest rates are going up, you can always pay ahead of time.

Disadvantages of variable interest rates

The disadvantages of variable interest rates depend on the market. Sometimes you'll end up paying a slightly higher rate than would be on a fixed interest loan. This is because of a shift in the market, because an increase in the rates charged in the loan market results in an increase to the variable rate that you pay with your loan. As interest rates change, your repayments must change also.

How discount rates work

As an example of how these discounts can work, assume the standard variable rate is 7.00% and the discount rate is 2.50%. To work out the discounted variable rate (i.e. the rate you will pay), simply subtract the discount rate from the variable rate, in this case 7.00 minus 2.50, giving a discounted rate of 4.50%. Once the introductory period has passed, however, the rate would return to the standard rate, which may still be at 7.00% or may have either increased or decreased in the time that the discount was in effect.

Rate discounts with variable interest rates

Lenders will give discounted rates to First Time Buyers. They may also give you this preferred rate if you transfer you mortgage to them, or for existing customers who are moving home again. The rate may also vary depending on the size of your mortgage the higher the mortgage, the higher the discount rate.

It is very important to remember that the discounted rate only lasts for a fixed period often 6 or 12 months. After that period, the lender's standard variable rate will apply. Of course, you should always check to see how long the discount rate is in effect before agreeing to a rate such as this? after all, if you aren't sure when the temporary rate is going to end then you may not be fully prepared for a sudden increase in payments due to your interest rate.

You may freely reprint this article provided the following author's biography (including the live URL link) remains intact:

Short note about the author

John Mussi is the founder of Direct Online Loans who help homeowners find the best available loans via the www.directonlineloans.co.uk website.

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