How does a variable rate loan differ from a fixed rate loan?

A variable rate loan is characterized by interest rates that fluctuate based on market indexes. This means that the interest rate can change at specified intervals—often in accordance with the performance of a benchmark rate or index, such as the LIBOR or the prime rate. As a result, monthly payments can vary over the life of the loan, increasing or decreasing depending on the movement of interest rates in the market. This offers borrowers the potential for a lower initial interest rate compared to fixed-rate loans, but also comes with the risk of higher payments if rates rise.

In contrast, with a fixed rate loan, the interest rate remains constant throughout the term, providing predictability in monthly payments. The repayment terms and overall loan amounts can vary widely with both types of loans, so those factors are not inherently characterized by either loan type. Thus, the key differentiator lies in how the interest rate behaves in relation to market conditions, making the second choice the correct one.