What Is a Variable Interest Rate?

There are two main types of savings accounts. One is a savings account with a fixed interest rate. The other is a savings account with a variable interest rate. Which one you choose depends on your own financial circumstances and goals. 

In this article, we’ll help you to understand the variable interest rate. We’ll look at the advantages of a variable rate, and the potential drawbacks of a variable rate.

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What is a variable interest rate?

A variable interest rate is one which can change at any time, without any input from you. You have no control over whether the rate goes up or down. 

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What determines the variable rate depends on several factors. The state of the economy, for example, can play a significant role in determining variable interest rates. 

The Bank of England Base Rate is a good example. The base rate is altered deliberately in order to influence spending, as well as lending rates and rates on savings accounts.

If the Bank of England rate rises and you have a savings account with a variable rate, then your interest rate could rise along with it. Good news for you. 

What are the advantages of a variable rate?

The two main advantages of a variable rate are the potential for higher returns and flexibility.‍

Because a variable rate can change according to movements elsewhere in the economy (or at the discretion of the bank or provider) the potential exists for higher returns, should the rate rise from, for example, 4% to 4.75%.

A variable rate also offers flexibility, especially if you know that you’ll receive a variable rate for a set period of time, say 18 months. This allows you to make more detailed savings plans according to your own personal goals. 

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What are the disadvantages of a variable rate?

The advantages of a variable rate also happen to be its disadvantages. With a fixed rate, while you won’t benefit from positive shifts elsewhere, you also won’t lose out.

But with a variable rate, if your bank or provider lowers their interest rate, your savings interest rate will be affected. This makes a variable rate less attractive during times of economic downturn or hardship.

It’s important to factor in these pros and cons when deciding on a savings account. You’ll almost certainly always earn at least some interest no matter which type you choose. Whether you want the absolute predictability of a fixed rate, or the potential ups and downs of a variable rate, though, is up to you.