What Is a Floating Rate of Interest or Floating Interest Rate?

A floating interest rate is one that fluctuates periodically: the interest rate rises and falls, or "floats," in response to economic or financial market conditions. Frequently, it moves in tandem with a specific index or benchmark, or with market conditions in general. It is also known as an adjustable or variable interest rate because it is subject to change over the life of the debt obligation.

Floating Interest Rate

In contrast to a fixed (or unchanging) interest rate, a floating interest rate fluctuates periodically.

• Floating interest rates are utilized by credit card companies and are prevalent in mortgages.

• Floating rates are also referred to as variable rates. 

• Floating rates track the market or an index or another benchmark interest rate.

Understanding Floating Interest Rates

A floating interest rate fluctuates in tandem with the market or another benchmark interest rate. The underlying benchmark interest rate or index varies based on the type of loan or security, but it is frequently associated with LIBOR, the federal funds rate, or the prime rate i.e. the interest rate of the financial institutions charge their most creditworthy corporate customers.

When it comes to consumer loans and debt (such as mortgages, auto loans, and credit cards), banks and financial institutions charge a spread over this benchmark rate, with the spread varying based on a variety of factors, including the type of asset and the consumer's credit rating. Thus, a floating rate may define itself as “the LIBOR plus 300 basis points" or "plus 3%."

Adjustments to variable interest rates may occur quarterly, semiannually, or annually.

All loans and debt instruments feature variable interest rates. However, they are especially prevalent with credit cards and mortgages.

Different Types of floating-rate products

Mortgages with variable interest rates are known as adjustable-rate mortgages (ARMs). The interest rate on an adjustable-rate mortgage (ARM) fluctuates based on a predetermined margin and a major mortgage index, such as LIBOR, the Cost of Funds Index (COFI), or the Monthly Treasury Average (MTA). For instance, if an individual obtains an ARM with a 2% margin based on LIBOR and LIBOR is at 3% when the mortgage's rate adjusts, the rate resets to 5%. (the margin plus the index).

The majority of credit cards charge variable or floating interest rates on unpaid balances. In the credit card agreement that new cardholders receive, the card's annual percentage rate (APR) will be described as such-and-such, based on such-and-such a rate or index plus a certain amount, or margin. Typically, they will add this “APR which will fluctuate with the market."

The majority of credit card interest rates are indexed with the prime rate, where the interest rate reflects directly which was set by the Federal Reserve several times per year.  The interest rate with a margin varies by card product and account holder's credit quality.

Floating Interest Rate vs Fixed Interest Rate

Contrast a floating interest rate with a fixed interest rate, in which the interest rate remains constant and does not fluctuate. It could apply for the duration of the loan or debt obligation, or just a portion of it.

You can obtain residential mortgages with either fixed or variable interest rates. With fixed interest rates, the mortgage interest rate is static and cannot change during the term of the mortgage contract. With floating or variable interest rates, mortgage interest rates are subject to periodic market fluctuations.

For instance, if a person obtains a fixed-rate mortgage with a 4% interest rate, he or she will pay that rate for the duration of the loan, and payment for the months will remain the same. In contrast, if a borrower obtains a mortgage with a variable interest rate, the rate may begin at 4% and then adjust upwards or downwards, altering the monthly payment.

Example of Floating Interest Rate Loan

Harry and Liza obtain a $600,000, 30-year, 7/1 adjustable-rate mortgage. This indicates that their loan's interest rate is fixed for seven years at 2%. At the end of this period, the mortgage interest rate resets to a variable rate that fluctuates annually and is pegged to the LIBOR. Therefore, their interest rate increases to 4% in the eighth year. In the ninth year, the LIBOR rate has decreased slightly, resulting in a reduction of their interest rate to 3.7%. In the tenth year, it drops to 3.5%. The couple's mortgage interest rate will continue to fluctuate annually until they pay off their mortgage in full or refinance.

Advantages and Disadvantages of Floating Rates

Some borrowers may find ARMs more appealing than fixed-rate mortgages due to their typically lower initial interest rates. Those who intend to sell the property and repay the loan before the rate adjusts or those who anticipate a rapid increase in equity as home values rise may opt for an adjustable-rate mortgage (ARM).

The other benefit is that variable interest rates may decrease, thereby reducing the borrower's monthly payments.

Obviously, the opposite could also occur. The primary disadvantage of a variable interest rate is that the rate may fluctuate upward, thereby increasing the borrower's monthly payments or even making them impossible. Overall, a loan with a variable interest rate is unpredictable, making it difficult to budget cash flow and estimate long-term borrowing costs. And unless you are the chair of the Federal Reserve, you have no control over the forces that govern the changes in interest rates.


When it comes to long-term borrowing, it is best to avoid floating-rate or variable-rate loans, and this is especially true given the current low interest rate environment.

It is essential to know precisely how much your debt will cost you in order to budget without surprises.

When you opt for a variable-rate loan, you are essentially betting that future interest rates will be lower. A fluctuating interest rate environment could introduce a new and potentially higher interest rate each year, which could substantially increase the amount of interest you must pay.

When interest rates are historically low, as they are now, it is likely that they will increase in the future rather than decrease, making a floating-rate loan a poor option. Therefore, a fixed-rate loan is the most prudent option, especially in the current interest rate environment.