Variable interest

If we take out a loan with a variable interest rate, we must take into account that the loan interest rate may change within the term. If the term is divided into interest periods and the interest is fixed within them, the interest can only change at the end of the interest periods.

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  • + Compared to fixed-rate loans, the part of the interest that the bank incorporates into the interest to cover its own risks is smaller.

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  • - Due to market conditions or even the perception of bank risk , loan conditions may deteriorate within the term, and repayment installments may increase.

Key related topics

Interest risk Central bank / National bank Interest rate spread

The fixed interest rate A loan is a simple, easy-to-calculate matter, but that is why it is often not really beneficial to have the interest rate fixed in advance for the entire term. Such a situation can be, for example, when a decreasing interest rate environment can be expected. 

Compared to a fixed interest rate, it has a variable interest rate for loans the interest (that interest therefore, from which our current installment is ultimately calculated) a during the term may change within. Of course, this also means that our installments can jump, increase or even decrease from month to month. This definitely brings unpredictability to our lives or business plans, their company to cash-flow. 

If the term is according to the loan agreement for interest periods is divided, then the interest, and with it our monthly installment, can only change at the end of the interest period , but then it stays with us until the end of the next interest period . The interest period is the period until the interest rate does not change, this can be 1-3 months in the case of corporate loans, or even 3-5-10 years in the case of residential mortgage loans.

The interest rate on variable rate loans typically consists of two components, a from the reference interest rate and the from interest surcharge. The sum of these is the interest. 

The task of the reference interest rate interest rate is to include changes in the external environment in the determination of the interest rate. The reference interest rate is usually given by a base or interbank interest rate listed and published by a central bank, which respond sensitively to the expectations of market participants, above all the inflationary expectations. It follows from this that the bank has no influence on the reference interest rate, it is a factor determined by external forces just as much as it is for the borrower. 

Another component of the interest is the interest spread, in which the bank displays the repayment risk of the given loan type, sector, or even of the loaned business or private individual. This component of the variable interest rate is determined by the bank. 

Last edited: January 10, 2023

Related topics

Financing
Fixed interest rate / Fixed rate Cash-flow / Cash-flow statement Credit Interest Term Inflation / Consumer price index Reference interest rate / Benchmark interest rate
Indicators, attributes
Interest Inflation / Consumer price index

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