What Is a Variable Interest Rate & How Does It Work?

Understanding how interest works is an important part of comparing borrowing options in Australia. If you’re researching loans, you’ve probably come across the question: what is a variable interest rate, and how is it different from a fixed rate?

In this guide, we explain what a variable interest rate means, how lenders may set these rates, when borrowers sometimes consider variable rates, and how variable-rate loans differ from fixed-rate options.

If you’d like to read more about how interest rates work generally, you may find this helpful:
What is an interest rate? https://www.credit24.com.au/blog/what-is-interest-rate

What is a variable interest rate?

A variable interest rate is an interest rate that can change over the life of a loan. If the interest rate changes, your repayment amount may also change depending on the loan terms.

Because the rate can move up or down, the total cost of borrowing may be less predictable over time compared with a loan that has a fixed interest rate.

Key characteristics of variable interest rates

• The interest rate can change during the loan term
• The lender may adjust the rate with notice in accordance with the loan agreement
• Repayments may increase or decrease depending on how the rate changes
• Variable rates are commonly used in products such as home loans, some personal loans, and some credit cards

In general, variable interest rates can provide flexibility in some loan products, but they may also create uncertainty because repayments can change.

How do variable interest rates work?

Lenders set variable interest rates based on a range of factors, including funding costs, market competition, and broader economic conditions.

One influence on lending costs across the financial system is the Reserve Bank of Australia (RBA) cash rate. Changes to the cash rate may affect borrowing costs for financial institutions. However, lenders set their own interest rates and may change variable rates independently of RBA decisions.

Because several factors can influence lending costs, variable rates may change even when the RBA cash rate remains unchanged.

How repayment amounts can change (simple example)

Changes in interest rates can affect repayments on longer-term loans such as home loans. The example below illustrates how repayments on a large loan may change when interest rates move. These figures are simplified and for illustration only.

For example, on a $400,000 loan over 30 years:

• At 3.5%, repayments might be around $1,796 per month
• At 4.0%, repayments might be around $1,910 per month (about $114 more)
• At 3.0%, repayments might be around $1,686 per month (about $110 less)

Actual repayments depend on factors such as the loan amount, loan term, fees, charges, and the interest rate applied. Loan features and repayment structures may also affect how repayment changes are applied.

Factors that influence variable interest rate changes

Variable interest rates can move for a range of reasons, including:

1. RBA cash rate movements

The RBA may adjust the cash rate in response to economic conditions such as inflation, employment trends and economic growth. These decisions can influence lending costs across the financial system.

2. Lender funding costs

Banks and other lenders obtain funding from different sources. If their cost of funding changes, they may review their interest rates.

3. Market competition

Lenders may adjust pricing to remain competitive or to reflect changes in the broader lending market.

4. Borrower and product risk factors

Interest rates can vary depending on the product type, lending criteria and how the lender assesses risk.

5. Economic conditions

Broader economic trends such as inflation, financial market conditions and economic growth can influence lending costs and interest rate settings.

Pros and cons of variable interest rates

Pros

Potential flexibility in some loan products Some variable-rate loan products may allow features such as additional repayments. Whether these features are available depends on the lender and the specific loan terms.

Repayments may decrease if interest rates fall
If the interest rate decreases, repayments may also decrease depending on the structure of the loan.

Possible refinancing flexibility in some cases
Some variable-rate products may have different conditions if you refinance or switch loans. Fees, charges and eligibility requirements vary between lenders.

Additional features in some home loan products
Some variable home loans may include features such as redraw or offset accounts, depending on the product.

Cons

Repayment uncertainty
If interest rates increase, repayments may also increase, which can make budgeting more challenging.

Higher repayment pressure when rates rise
Rapid increases in interest rates can place pressure on household budgets.

Less predictable total cost
Because the interest rate can change during the loan term, the total interest paid over the life of the loan may be harder to estimate.

Variable vs fixed interest rates: Key differences

Below is a general comparison of how variable and fixed interest rates may differ. Features and terms vary between lenders and products.

Rate stability

Variable: the interest rate can rise or fall
Fixed: the interest rate is set for a defined period or the loan term (depending on the product)

Extra repayments

Variable: some products may allow more flexible extra repayments
Fixed: additional repayments may be limited or may involve fees depending on the loan terms

Costs to exit early

Variable: exit or break costs may differ depending on the lender and product
Fixed: ending a fixed-rate loan early may involve break costs in some circumstances

Loan features

Variable: some products may offer additional features depending on the loan structure
Fixed: features may vary and may be more limited in some products

Budget certainty

Variable: repayments may change over time
Fixed: repayments are generally more predictable during the fixed-rate period

If you’re comparing both types of rates, you may also want to read:

What is a fixed interest rate?
https://www.credit24.com.au/blog/what-is-a-fixed-interest-rate

Fixed or variable personal loan: how to choose
https://www.credit24.com.au/blog/fixed-or-variable-personal-loan

When might borrowers consider a variable interest rate?

Some borrowers consider a variable rate in situations such as:

• When their budget can accommodate potential interest rate changes
• When flexibility in loan features is important to them (if the loan product offers those features)
• When they want a loan structure where repayments may move with changes in interest rates
• When they want to compare variable-rate products alongside fixed-rate options

A variable interest rate may not suit borrowers who prefer repayments that remain consistent over time.

Tips for managing a variable interest rate loan

If you have a variable-rate loan, the following general considerations may help you understand and manage repayment changes:

Build a financial buffer if possible
When repayments are manageable, some borrowers choose to set aside additional funds to help manage potential rate increases.

Understand how your repayments work
Review your loan terms to understand how interest rate changes affect your repayment schedule.

Maintain an emergency savings buffer
Savings can help manage unexpected expenses or changes in income.

Stay informed about economic conditions
Following economic news, including RBA announcements, may help you understand broader trends that can influence interest rates.

Review your loan periodically
Over time, comparing loan terms, interest rates and fees may help you decide whether your current product still meets your needs.

Fixed-rate personal loans and repayment certainty

Some lenders offer personal loans with fixed interest rates. With these products, the interest rate remains the same for the agreed loan term.

Because the rate does not change during the fixed period, repayments are typically set according to the agreed loan terms, which can make budgeting more predictable for some borrowers.

Credit24 fixed-rate personal loans

Credit24 offers personal loans with a fixed interest rate for the loan term. This means the interest rate remains the same during that period.

Depending on eligibility and product details, Credit24 personal loans may include:

• A fixed interest rate for the loan term
• A repayment schedule outlining expected repayments under the loan terms
• Fees and charges disclosed in the product information
• A fully online application process
• Loan amounts up to $10,000 (subject to eligibility and lending criteria)
• Applications assessed in accordance with responsible lending obligations under the National Consumer Credit Protection Act

Apply now:
https://www.credit24.com.au/au/apply/login

Disclaimer

IPF Digital Australia Pty Ltd, trading as Credit24, ABN 59 130 894 405. Australian Credit Licence 422839.

The information in this article is general in nature and does not take into account your objectives, financial situation or needs. Lending criteria, fees and charges apply. For product details, eligibility requirements and full terms and conditions, visit www.credit24.com.au.