What Is a Floating Interest Rate?

A floating interest rate is an interest rate that changes periodically. The rate of interest moves up and down, or "floats," reflecting economic or financial market conditions. Often, it moves in tandem with a particular index or benchmark or with general market conditions.

Credit cards and some 澳洲幸运5官方开奖结果体彩网:mortgage loans come with floating interest rates, also called adjustable or 澳洲幸运5官方开奖结果体彩网:variable interest rates, because they can vary over the term.

Understanding Floating Interest Rates

Many types of loans and debt instruments carry floating interest rates, including credit cards and mortgages. A floating 澳洲幸运5官方开奖结果体彩网:interest rate rises or falls with the overall market or mirrors a 澳洲幸运5官方开奖结果体彩网:benchmark interest rate.

The underlying benchmark rate or index depends on the type of loan or security, but it is often either the 澳洲幸运5官方开奖结果体彩网ꦍ:Secured Overnight Financing R🧔ate (SOFR), the 澳洲幸运5官方开奖结果体彩网:federal funds rate, or the 澳洲幸运5官方开奖结果体彩网:prime rate (the interest rate financial institutions charge their most creditworthy corporate customers).

澳洲幸运5官方开奖结果体彩网:Financial institutions usually charge a spread  over the benchmark rate for consumer credit products like personal loans, 澳洲幸运5官方开奖结果体彩网:mortgages, car loans, or credit cards. The spread depends on several factors, including the type of credit or the consumer’s 澳洲幸运5官方开奖结果体彩网:credit rating. Thus, a bank might state the floating rate for a loan as “the SOFR plus 300 basis points" or "plus ꦫ3%."

Types of Floating-Rate Products

Home loans that carry floating rates are known as adjustable-rate mortgages (ARMs). ARMs have rates that adjust based on a preset margin (or spread) and a mortgage index such as SOFR, the 澳洲幸运5官方开奖结果体彩网:Cost of Funds Index (COFI), or the 澳洲幸运5官方开奖结果体彩网:Monthly Treasury Average (MTA).

For example, if an individual takes out an ARM with a 2% margin over the SOFR, and SOFR is at 3% when the mortgage's rate adjusts, the mortgage rate resets to 5% (the margin plus the index).

Most credit cards charge floating or variable interest rates on unpaid balances. The credit card agreement that new cardholders receive will state that the card's annual percentage rate (APR) is based on a particular rate or index plus a certain percentage (or margin). The agreement may include text such as "this APR will vary with the market."

Floating Interest Rate vs. Fixed Interest Rate

A floating interest rate contrasts with a fixed interest rate. With a fixed interest rate, 🉐the rate is constant and may apply to the entire loan term or debt obligation or just part of it.

澳洲幸运5官方开奖结果体彩网:Residential mortgages come with either fixed or floating interest rates. With fixed interest rates, the 澳洲幸运5官方开奖结果体彩网:mortgage interest rate cannot change for the duration of the mortgage agreement. With floating or variable interest rates, the mor🍒tgage interest rates can change periodically with the market.

For example, if someone takes out a fixed-rate mortgage with a 4% interest rate, the individual will pay that rate for the lifetime of the loan,෴ and the payments will be t🦄he same throughout the loan term.

In contrast, if a borrower takes out a 澳洲幸运5官方开奖结果体彩网:mortgage with a variable rate, it may start with a 4% rate and then adjust, either up or d🗹own, changing the monthly payments over the life of the loan.

Example of a Floating Interest Rate Loan

Herbert and Amanda buy a house and take out a $500,000, 30-year 7/1 ARM. When they take out ⛦the loan, rates are low, and they initially get a 2% interest rate on the ARM.

For the first seven years, the loan's rate remains fixed at 2%. At the end of that time, the mortgage resets to a floating interest rate, which changes once a year. The floating rate tracks the SOFR.

• In the eighth year, their loan's floating interest rate rises to 4%, reflecting the SOFR.
• In the ninth year, the SOFR rate dropped slightly, decreasing their rate to 3.7%.
• In the 10th year, the SOFR decreases again, pushing the couple's floating rate lower to 3.5%.

The interest the couple pays on the mortgage will fluctuate, and the rate will reset annually until they pay off the mortgage or 澳洲幸运5官方开奖结果体彩网:refinance the ARM to a fixed-rate mortgage loan.

Advantages and Disadvantages of Floating Rates

Advantages

• Floating-rate mortgages tend to have lower introductory interest rates than fixed-rate mortgages. As a result, the low introductory rate can appeal to some borrowers since it lowers the monthly payment and helps boost approval odds.
• ARMs can appeal to those who plan to sell their property and repay the loan before the rate adjusts or borrowers who expect their equity to increase quickly as home values rise.
• Floating interest rates may float down, thus lowering the borrower's monthly payments.

Disadvantages

• The key disadvantage of a floating rate is that the rate may float upward and increase a borrower's monthly payments, even perhaps to the point of making those payments impossible.
• The unpredictability of a floating rate loan can make it challenging to budget cash flow and calculate the long-term borrowing costs.
• Taking out a floating-rate credit product or loan means you are at the mercy of market interest rates.

The Bottom Line

A floating interest rate, otherwise known as a variable interest rate, fluctuates periodically in line with the benchmark rate to which it's pegged. As the benchmark rate increases, so does the floating interest rate, and vice-versa.

If a floating rate drops, borrowers will save money with lower monthly payments. However, if a floating rate rises, borrowers will pay a higher interest rate, pushing the monthly payment higher. The 𝐆risk of higher borrowing costs represents the primary disadvantage of credit products with floating interest rates.