Two Times When A Variable-Rate Personal Loan Is A Good Idea

Many financial experts recommend against variable-rate loans because of the risk the interest rate will increase abruptly, leading to a corresponding increase in the monthly payment due. While this can be problematic in some situations, here are two times when getting a variable-rate loan is actually a good idea.

You'll Pay the Loan Off Quickly

Banks that provide variable-rate loans typically offer low starting interest percentages (or teaser rates) to entice people to apply for them. This rate typically lasts for a short period of time (e.g. 12 months) before it changes to the real market percentage. Thus, if you can pay the loan off during the time when the rate is likely to be at it's lowest point, then you may want to consider signing up for a variable-rate loan, since this can save you quite a bit of money in the long run.

Alternatively, another option is to refinance the loan at a percentage that will be lower than the market rate when the introductory period ends. For instance, if the teaser rate you get is 3 percent and you expect it will rise to 5 percent, refinancing the loan at a fixed 4 percent can help you avoid the step rate hike and keep your payments reasonable.

Be aware, though, that some banks may require you to keep the loan for a minimum period of time or charge you a prepayment fee to make up for the interest they lose when you pay the loan off early, so be sure to read the loan terms carefully and choose a bank that doesn't charge these fees.

The Interest is Capped at a Reasonable Rate

Another reason a variable-rate loan may be a good option is if it is capped at a reasonable level. Floating-rate loans are typically based on a particular market force. For instance, the bank may price the loan at two percentage points above whatever the London Interbank Offered Rate (LIBOR) is. So if the LIBOR percent jumps from 5 to 10 percent, your interest rate would increase sharply from 7 to 12 percent.

On a loan with no caps, there's no limit to how high your interest rate could go. Thus, you should only consider a variable-rate loan if it has a reasonable rate cap, meaning it won't go above a certain level regardless of what the market force does. This ensures you won't end up paying an exorbitant rate that makes the loan unaffordable.

For more information about variable-rate loans or to apply for a personal loan, contact a lender like US Community Credit Union.