What is a 'Floating Interest Rate'

A floating interest rate is an interest rate that moves up and down with the rest of the market or along with an index. It can also be referred to as a variable interest rate because it can vary over the duration of the debt obligation. This contrasts with a fixed interest rate, in which the interest rate of a debt obligation stays constant for the duration of the loan's term.

BREAKING DOWN 'Floating Interest Rate'

Residential mortgages can be obtained with fixed interest rates, which are static and cannot change for the duration of the mortgage agreement, or with a floating or adjustable interest rate, which changes periodically with the market. For example, if someone takes out a fixed rate mortgage with a 4% interest rate, he pays that rate for the lifetime of the loan, and his payments are the same throughout the loan's term. In contrast, if a borrower takes out a mortgage with a variable rate, it may start with a 4% rate and then adjust, either up or down, thus changing the monthly payments.

How Floating Interest Rates Adjust

In most cases, adjustable-rate mortgages (ARMs) have rates that adjust based on a preset margin and a major mortgage index such as Libor, the cost of funds index (COFI) or the monthly treasure average (MTA). For example, if someone takes out an ARM with a 2% margin based on Libor, and Libor is at 3% when the mortgage's rate adjusts, the rate resets at 5% (the margin plus the index).

Credit Cards With Floating Interest Rates

Mortgages are not the only type of loans that can have floating interest rates. Most credit cards also have floating interest rates. As with mortgages, these rates are tied to an index, and in most cases, the index is the current prime rate, the rate that directly reflects the interest rate set by the Federal Reserve several times per year. Most credit card agreements state that the interest rate charged to the borrower is the prime rate plus a certain spread.

Advantages and Disadvantages of Floating Rates

With mortgages, adjustable-rate mortgages tend to have lower introductory interest rates than fixed rate mortgages, and that can make them more appealing to some borrowers, especially to borrowers who plan to sell the property and repay the loan before the rate adjusts or borrowers who expect their equity to increase quickly as home values increase. The other advantage is that floating interest rates may float down, thus lowering the borrower's monthly payments. The key disadvantage, however, is that the rate may float upward and increase the borrower's monthly payments.

RELATED TERMS
  1. Floating Rate Fund

    A floating rate fund is a fund that invests in financial instruments ...
  2. Reference Rate

    A reference rate uses benchmarks, like the prime rate and the ...
  3. Adjustable-Rate Mortgage - ARM

    An adjustable rate mortgage is a type of mortgage in which the ...
  4. Mortgage Rate

    A mortgage rate is the rate of interest charged on a mortgage. ...
  5. Home Mortgage

    A home mortgage is a loan given by a bank, mortgage company or ...
  6. Mortgage Interest

    Mortgage interest is the interest paid by homeowners on the financing ...
Related Articles
  1. IPF - Mortgage

    Mortgages: Fixed Rate vs. Adjustable Rate

    Both fixed rate and adjustable rate mortgages have advantages and disadvantages, depending on your financial needs and prospects.
  2. Investing

    Float Over to Floating Rate ETFs

    Floating rate notes are another avenue for bond investors to consider when it comes to reducing interest rate risk.
  3. IPF - Mortgage

    Mortgage Rates

    View current daily average mortgage rates for fixed and adjustable rate loans. Learn more about mortgage rates and how we can help you reach your home ownership goal.
  4. Financial Advisor

    Effect of Fed Fund Rate Hikes on the Housing Market

    Understand what drives the federal funds rate and why the Fed would increase that rate. Learn about the effect of a rate increase on the housing market.
  5. Investing

    Floating Rate Loans Look Attractive

    The search for income continues to remain a major priority for investors, as interest rates still sit at historically low levels. In order to get yield, many have moved up the maturity ladder. ...
  6. IPF - Mortgage

    Mortgage Calculator

    Calculate monthly mortgage payments with our free mortgage calculator. Avoid costly mistakes and make the right financial decision when buying a house.
  7. Investing

    Mortgages: Fixed Rate Versus Adjustable Rate

    Choosing the right mortgage can help homebuyers avoid costly mistakes. Learn the difference between fixed- and adjustable-rate loans.
  8. Personal Finance

    It's All Related: Interest, Mortgages, the Economy

    The article looks into the relationship between the economy, interest rates and mortgage rates.
  9. Investing

    Financing Basics For First-time Homebuyers

    If you're buying your first home and getting a mortgage, you have many financing options to sort through.
  10. Personal Finance

    Reduce Interest With an All-in-One Mortgage

    "Offset" mortgages combine a checking account, home-equity loan and mortgage into one account.
RELATED FAQS
  1. What exactly is a company's float?

    The term "float" refers to the regular shares that a company has issued to the public that are available for investors to ... Read Answer >>
Trading Center