Floating Interest Rate
What is a Floating Interest Rate?
A floating interest rate is an interest rate that can change from time to time.
Floating Interest Rate Example
Let's say you want to borrow $5,000 to start a business. Company XYZ offers you a floating interest rate loan at plus 5%. That means the interest rate on the loan equals whatever the prime rate is plus 5%. So if the prime rate is 4%, then your loan carries an interest rate of 9%. The bank may "reset" the rate from time to time as the prime rate changes. This means that if the prime rate goes up, your rate goes up; if the prime rate goes down, your rate goes down. This helps the bank avoid losing if the prime rate happens to go up after it has granted you the loan. It also helps you avoid overpaying for the loan if prime rates happen to go down after you take out the loan.
In another example, if your mortgage interest rate is a floating rate (that is, it is adjustable), your rate rises and falls with the and you and your payments get to go along for the ride. This is great when rates are falling, but when rates are rising, hang on (or try to refinance into a fixed-rate mortgage).
What Floating Interest Rates Matter
It's important to remember that interest rates don't just change by themselves. There's usually a trigger, such as economic information about consumer spending or business inventories. And given that the nation's thousands of banks make their own determinations about what they're willing to pay forand charge for , there is no one person or entity that "sets" interest rates.
For example, the London Interbank Offered Rate (LIBOR) operates on the same philosophy (though the calculations are different). In any case, interest rates are really a matter of supply and demand.
Interest rates are some of the most powerful and influential components of any , which is why most countries' central banks take a keen interest if not an active role in monitoring interest rates. They also affect individual, day-to-day consumer decisions, such as determining whether it's a good time to buy a house, borrow for a college degree, or money in the bank. After all, the higher interest rates are, the less borrowing (and thus economic expansion) takes place; the lower interest rates go, the more borrowing (and economic expansion) takes place. They affect prices, derivatives trading, markets, and the size of every investor's future nest egg.