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.
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Finance: What is the difference between ...6 Views
Finance allah shmoop what's the difference between a fixed and
a floating rate All right well we'll just start this
one out with your favorite time Donald and melania need
to borrow money to buy a building here's the history
of ten year t bill costs for the last few
decades Well rates were almost ten percent in the nineteen
seventies and then they fell all the way to being
almost free in two thousand eighteen Well if donald had
borrowed money nineteen eighty to buy a building with us
fixed rate he'd have had to pay about ten percent
interest for all this time That raid in nineteen eighty
was fixed and you know i'd be paying ten percent
for thirty five years very expensive rent on that money
It's not like a dog who can't you know have
pups different kind of fixed you know it's fixes in
he won't move Position is just a set number fixed
in place All right well donald would have overpaid massively
in his loans by paying ten percent interest when he
could have been paying seven percent here and four percent
here And maybe like two percent change here if the
loan he'd taken out in nineteen eighty was floating well
it would have floated downward along the way like that
Well most for floating loans have a preset set of
terms which move along with the rates of the fed
charges to loan money to banks who then mark up
the loans a bit and resell the money to really
borrowers like donald and kill you and me That is
the floating rate might be set at quote the average
federal funds rate plus ah hundred faces points over the
trailing six month period to be reset every month Unquote
Yeah something like that So in this case his rate
would have floated downward And obviously things can go the
other way as well Joe six pack it's a mortgage
for a home he can barely afford today Eight hundred
grand mortgage at four percent Well it cost him thirty
two grand a year to rent that money just the
interest and he has to make principal payments as well
So is total payments or something like forty grand a
year in year one of thirty Well if rates go
back up and they easily could and become say seven
Percent instead of that four percent a few years later
three four five years later Well then all of a
sudden his cost of renting that money goes from thirty
two grand a year in interest costs too something like
fifty or sixty grand a year in interest costs And
joe six pack because he didn't fix his raid at
that four percent figure when he borrowed it let things
float and well he ended up you know living in
his car when he couldn't afford paying The mortgage owns
home anymore and had to sell it And so yeah
he's living in his suv down by the river But 00:02:45.5 --> [endTime] luckily for him that suv floats
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