Adjustable-Rate Loan

What Is an Adjustable-Rate Loan?

An adjustable-rate loan is a loan with an interest rate that can change periodically based on movements in a benchmark interest rate. Unlike fixed-rate loans, where the interest rate remains constant, adjustable-rate loans allow the interest rate to increase or decrease over time.

Adjustable-rate loans are commonly used in mortgages, student loans, and some business loans.

Why It Matters

Adjustable-rate loans can offer lower initial interest rates than fixed-rate loans, which may make borrowing more affordable in the short term. However, because the interest rate can change, borrowers face the risk that payments could increase if market interest rates rise.

Understanding adjustable-rate loans helps borrowers evaluate the potential risks and benefits before committing to a loan.

How Adjustable-Rate Loans Work

Adjustable-rate loans typically use a benchmark rate—such as SOFR—plus a fixed margin to determine the loan’s interest rate.

The rate adjusts at specified intervals, such as annually or every few months.

Key components include:

benchmark rate
lender margin
adjustment schedule
rate caps (limits on how much the rate can increase)

When the benchmark rate changes, the loan’s interest rate adjusts accordingly.

Example

A mortgage may start with a 4% interest rate for the first five years. After that period, the rate adjusts annually based on SOFR plus a lender margin.

If the benchmark rate rises, the borrower’s monthly payment may increase.