Floating Rate

Also known as a “variable rate,” a floating rate is basically an unfixed interest rate. It floats with some index; that is, as that index (say, LIBOR) goes up, then that floating rate goes up with it as "LIBOR plus 50 basis points," or something like that.

When interest rates are high, taking out a loan with a floating rate might be a good thing, because it would allow borrowers to adjust their interest rate costs as interest rates change, presuming they'll go lower in the future. But if interest rates are super-low already, a loan with a fixed rate might be a safer bet, since it could protect borrowers against paying more when interest rates rise.

Let’s say we want to buy a house, and we have two loan choices: one has a fixed rate of 4.35%, and one has a floating rate that is currently sitting at 3.25%. In the short term, the 3.25% loan looks a lot better, because 3.25 is less than 4.35 (mind=blown, right?). Which means we’ll be paying less in interest. But if we look at interest rate trends and see that 3.25% is likely the lowest interest rate we’re ever going to see, and we think rates will rise to 5-6-7% neighborhoods, then we might decide to go for the fixed-rate loan, paying a higher price today but likely less in the future.

The term “floating rate” can also refer to a currency’s exchange rate. Sometimes a country decides to “fix” its currency rate, and sometimes it decides to let it be determined by the markets. Those market-determined currency rates are considered floating rates.

See: Bretton Woods. See: Exchange Rate.