What Is Variable APR?
When taking out a small business loan, you might encounter a variable annual percentage rate VS. a fixed annual percentage rate. What do these terms mean for your business?
What is a variable APR? And how does it compare to a fixed APR? You’ll run into these terms when seeking business funding like small business loans, lines of credit, or credit cards.
We’re here to answer all of your questions about variable APRs, so you can feel confident before signing any contracts with lenders or other financial institutions.
Table of Contents
What Is A Variable APR?
If you’re not sure what an annual percentage rate (APR) is, check out our beginner’s guide to APR for small business loans, and then come back here to learn specifically about variable APRs!
In your business finance journey, you’ve probably encountered a new term: variable APR.
If your loan or credit card has a variable APR, it simply means that your interest rate will change over time.
Fluctuations in a variable APR interest rate are based on an interest rate index that’s used as a benchmark for lenders. Most lenders use the Wall Street Journal Prime Rate, which uses the base rates on corporate loans posted by at least 70% of the nation’s top 10 banks.
While interest rates are always based on the prime rate, the number of percentage points a lender adds to your rate is based on your risk as a borrower.
Low-risk borrowers (established businesses with high revenue and solid credit histories) will have fewer percentage points added to the prime rate.
High-risk borrowers (newly opened businesses with low credit scores and/or revenues) will have more percentage points added to the prime rate. This makes the overall cost of a loan more expensive for higher-risk borrowers.
Regardless of your borrowing status, a variable APR will result in fluctuations in your APRs based on changes to the interest rate index.
TLDR: If the prime rate increases, so does the APR. If the prime rate drops, so does the APR.
Fixed APR VS Variable APR
Interest rates for financing options with fixed-rate APRs never change.
If your APR is 5%, it will be 5% for the life of the loan. The rate doesn’t change when the prime rate increases or decreases, unlike a variable APR.
There are some circumstances where an APR can change, even if it’s a fixed-rate product.
If you have a fixed-rate credit card, the APR could change, but it has to remain fixed for at least a full year. If it does change, you’re entitled to a 45-day notice from your lender/issuer before the APR changes.
If you have a fixed-rate loan, the APR could also change, but the lender has to notify you in writing. Lenders that do this will often offer a grace period to allow you to pay off the debt and close your account/transfer the balance before the new APR terms are applied.
Pros And Cons Of Fixed APRs
- You are protected from rising interest rates
- You know your monthly payments for the entire life of the loan
- If the interest rate index drops, you won’t benefit
- Fixed-rate loans are often less flexible in terms of repayment
- You might pay more in interest over time if the rate index drops dramatically while you are repaying your loan
Pros And Cons Of Variable APRs
- If the interest rate index falls, your loan payments can as well
- The variable APR for your loan might be lower than a fixed rate APR when you’re first taking the loan out
- Some lenders offer opening perks like a 0% introductory APR for a specified period
- When your interest rate rises, so will your loan payments
- It can be harder to budget in advance with a variable APR loan
- A dramatic rate increase can put your ability to pay on time in danger
Fixed APR VS Variable APR Final Thoughts
Regardless of how you feel about variable or fixed APRs, the reality is that you might not have a choice in the matter.
A variable APR might be best for your business for short-term use, while a fixed APR could benefit you in the long run. But these aren’t hard and fast rules.
Long-term business loans like Small Business Administration 7(a) loans have variable interest rates and are some of the most competitively-priced and affordable long-term loan options for small business owners.
No matter what you decide, make sure you keep an eye out for sneaky introductory rates. Credit card issuers are notorious for offering low and attractive APRs for the first 6 to 12 months. The rate will then increase sometimes from a fixed APR to a variable APR after this time.
Read all disclosures and agreements before opening an account to avoid any nasty surprises at the end of that introductory period.
APR is one of the most important things to consider before applying for any kind of business financing, but it’s not the only factor when researching lenders.
Your goal is to get rates and terms that work for you and your business. Shop around, research, and read everything.
Don’t want to mess with APRs and shady lenders? The best small business loans and the best small business credit cards won’t have APRs. Also, look into small business grants for the closest thing to free money the world has to offer.