How does a variable interest rate loan work?

A variable interest rate loan has an interest rate that changes periodically based on an underlying benchmark or index, such as the prime rate or SOFR. When that benchmark rises, your interest rate and monthly payment increase; when it falls, your payment decreases. These loans typically start with a lower rate than fixed-rate loans, which can save money initially. However, they carry the risk of rising payments over time. Lenders usually set caps that limit how much the rate can increase per adjustment period and over the life of the loan, protecting borrowers from extreme spikes. Variable rate loans are common in mortgages, home equity lines of credit, and student loans.