Floating interest rate

A floating interest rate, also known as a variable or adjustable rate, refers to any type of debt instrument, such as a loan, bond, mortgage, or credit, that does not have a fixed rate of interest over the life of the instrument.

Floating interest rates typically change based on a reference rate (a benchmark of any financial factor, such as the Consumer Price Index). One of the most common reference rates to use as the basis for applying floating 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 debt will usually be referred to as a spread or margin over the base rate: for example, a five-year loan may be priced at the six-month LIBOR + 2.50%. At the end of each six-month period, the rate for the following period will be based on the 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.

Interest rate

An interest rate is the rate at which interest is paid by borrowers (debtors) for the use of money that they borrow from lenders (creditors). Specifically, the interest rate is a percentage of principal paid a certain number of times per period for all periods during the total term of the loan or credit. Interest rates are normally expressed as a percentage of the principal for a period of one year, sometimes they are expressed for different periods such as a month or a day. Different interest rates exist parallelly for the same or comparable time periods, depending on the default probability of the borrower, the residual term, the payback currency, and many more determinants of a loan or credit. For example, a company borrows capital from a bank to buy new assets for its business, and in return the lender receives rights on the new assets as collateral and interest at a predetermined interest rate for deferring the use of funds and instead lending it to the borrower.

Interest-rate targets are a vital tool of monetary policy and are taken into account when dealing with variables like investment, inflation, and unemployment. The central banks of countries generally tend to reduce interest rates when they wish to increase investment and consumption in the country's economy. However, a low interest rate as a macro-economic policy can be risky and may lead to the creation of an economic bubble, in which large amounts of investments are poured into the real-estate market and stock market. In developed economies, interest-rate adjustments are thus made to keep inflation within a target range for the health of economic activities or cap the interest rate concurrently with economic growth to safeguard economic momentum.