Variable
Rates
In business and finance,
floating
interest
rates, a
floating
rate,
variable
rate or
adjustable
rate refers
to any type
of loan,
bond,
mortgage or
credit that
does not
have a fixed
rate of
interest
over the
life of the
loan. Such
loans
typically
use an index
or other
base rate
for
establishing
the interest
rate for
each
relevant
period. One
of the most
common rates
to use as
the basis
for applying
interest
rates is the
London
Inter-bank
Offered
Rate, or
LIBOR (the
rates at
which large
banks lend
to each
other).
The rate for
such loans
will usually
be referred
to as a
spread or
margin over
the base
rate: for
example, a
five-year
loan may be
priced at
six-month
LIBOR +
2.50%. At
the end of
each
six-month
period, the
rate for the
following
period will
be based on
LIBOR at
that point
(the reset
date), plus
the spread.
The basis
will be
agreed
between the
borrower and
lender, but
1, 3, 6 or
12 month
money market
rates are
commonly
used for
commercial
loans.
Banks may
prefer to
lend to
their
customers
with
floating
rates, since
they are
raising
funds
(through
deposits,
bond issues,
and by
borrowing
from other
banks or the
money
market).
Pricing
loans to
their
customers in
the same
currency and
basis allows
banks to
manage the
balance
between
their assets
and
liabilities.
Typically,
floating
rate loans
will cost
less than
fixed rate
loans,
depending in
part on the
yield curve.
In return
for paying a
lower loan
rate, the
borrower
takes the
interest
rate risk:
the risk
that rates
will go up
in future.
In cases
where the
yield curve
is inverted
yield curve,
the cost of
borrowing at
floating
rates may
actually be
higher; in
most cases,
however,
lenders
require
higher rates
for
longer-term
fixed-rate
loans,
because they
are bearing
the interest
rate risk
(risking
that the
rate will go
up, and they
will get
lower
interest
income than
they would
otherwise
have had).
Certain typs
of floating
rate loans,
particularly
mortgages,
may have
other
special
features
such as
interest
rate caps,
or limits on
the maximum
interest
rate or
maximum
change in
the interest
rate that is
allowable.
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