What Is a Floating Interest Rate?

What Is a Floating Interest Rate?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A floating interest rate, also known as a variable or adjustable rate, is a type of interest rate that can change over the duration of the loan period. It usually fluctuates in relation to an index or a standard rate as set by the banks. The adjustable nature of floating rates leads to varying loan installment amounts over the debt period.

For instance, if you have a mortgage with a variable rate, your payments could go up or down over time because of alterations in the benchmark interest rate your mortgage is tied to. For borrowers, the risk of rising rates is the main disadvantage of floating interest rate loans. But, on a positive note, this type of rate allows borrowers to avail a lower initial rate compared with fixed rate loans.

Related Questions

1. What is a fixed interest rate?

A fixed interest rate refers to an interest rate on a liability, like a loan or mortgage, that remains the same either for the entire term of the loan or for part of the loan term. This provides stability and predictability for budgeting purposes, as it allows borrowers to know exactly how much they will have to pay each month towards their loan.

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2. What’s the key difference between floating and fixed rates?

The main difference is that fixed rates remain constant over the loan period, allowing for predictable monthly payments. On the other hand, floating rates change over time as per market conditions, meaning monthly payments can increase or decrease.

3. Are floating rates better than fixed rates?

It depends on several factors. While floating rates tend to be initially lower than fixed rates, they come with a risk due to fluctuating market conditions. If interest rates rise, so do your repayments. Conversely, if rates drop, so will your installment amount. Therefore, the decision should depend on your financial stability, risk tolerance level, and market predictability.

4. What impacts floating interest rates?

Floating interest rates are primarily influenced by market forces of supply and demand. Additionally, economic factors such as inflation and monetary policies also affect floating rates.

5. Can I switch from a floating interest rate to a fixed one?

Yes, most financial institutions allow borrowers to switch from a floating interest rate to a fixed one. But it often depends on the terms of your loan and it could involve certain fees. It’s advisable to talk with your lender to understand the nuances of making this change.