I always assumed that every loan held a flat rate’my credit card, a house payment, a car payment. Oh to be naive! The truth, as many of you know, is that loans don’t always have set rates. Heck, we rushed to consolidate our student loans a month ago and credit card rates hardly remain steady. Interest comes in two general types:

Variable rate loans: interest rate fluctuates up and down to reflect the rise and fall in interest rates paid to savers by the lender
Fixed rate loans: pay the same percentage on your interest rate every time.

Which is better? My old finance professor told our class, “Fixed is forever,” meaning that you typically want your long-term loans to hold fixed rates. He said, “Hold variable very little.” Variable rates are typically best for short-term loans in the most general sense.

The interest rate that you’re being charged comes from a combination of two factors:
Index rate + margin
The index rate is a rate that reflects current market conditions and can easily be verified. The most popular index is based on interest rates of all securities and treasuries from 3-month bills to 30-year bonds. Known as a 1-year constant maturity treasury, this rate is published by the Federal Reserve based upon their daily calculations.
A lender obviously isn’t going to charge only an index rate. They’re about profit, right? They throw in their margin‘the cost of doing business, risk of loss on the loan, and bucks in their hands. This addition ranges from 2 to 3 percent.

If you’ve got that variable rate mortgage or you’re considering, a few notes I’ve learned over time:
The amount of time between adjustments’the adjustment period‘ranges from six-months to five-years, though typically adjusted once a year. Now you’ll benefit from longer adjustment periods when the market rates are rising of course. You’ll also benefit from shorter periods if the index is decreasing since it’ll show up in your monthly payments sooner.

With the way things are going now (UP), you’ll be glad to know that an interest rate cap (aka ceiling) sets how much interest can increase for any one adjustment period during the life of your loan. That way, you can’t get dumped with added interest rates. A payment cap is also set, limiting how much your monthly payments can increase in one year.