What is the primary risk associated with taking a variable rate loan?

• A. The interest rate may increase over time, leading to higher loan payments.
• B. The borrower cannot pay off the loan early without penalty.
• C. The interest rate is fixed and cannot decrease if market rates fall.
• D. The loan must be repaid in a single lump sum at maturity.

Answer: (A)

Verified step by step guidance

1. Understand the concept of a variable rate loan: A variable rate loan is a type of loan where the interest rate fluctuates over time based on changes in a benchmark interest rate, such as the prime rate or LIBOR.
2. Identify the primary risk associated with variable rate loans: The main risk is that the interest rate may increase over time, which can lead to higher loan payments for the borrower.
3. Compare the given options: Evaluate each option to determine which one aligns with the primary risk of a variable rate loan. For example, penalties for early repayment or fixed interest rates are not directly related to the risk of fluctuating interest rates.
4. Focus on the correct answer: The correct answer is the one that highlights the possibility of increasing interest rates and higher payments, as this is the defining risk of variable rate loans.
5. Conclude the analysis: Summarize why the other options are incorrect, emphasizing that they do not address the core risk of interest rate variability in this type of loan.