A Quick Intro To The Floating Interest Rate

When you apply for a mortgage, you can choose from a wide variety of loan options. You can opt for a shorter-term mortgage, one you can pay off in 10 or 15 years, or a longer-term loan that can take 30 years to pay off. Another home loan option you’ll need to decide is whether the mortgage will have a fixed or floating interest rate.

What Is A Floating Interest Rate?

A floating interest rate changes periodically throughout the life of your loan. Depending on the economy and market conditions, your mortgage interest rate will either “float” up or down. In most cases, a floating rate is linked to a specific index or another benchmark.

In the mortgage industry, loans with floating rates are called adjustable-rate mortgages (ARMs). For other consumer products with floating rates, such as credit cards or personal lines of credit, the term “variable interest rate” is more common.

Mortgages with floating interest rates usually start with a fixed introductory period. The rate stays the same during this period, typically 5 – 10 years. For example, suppose you take out a 30-year mortgage with a floating interest rate. Your lender may offer a fixed rate for the first 5 years of the loan’s term. After 5 years, the rate will adjust annually. This means your rate could change for the remaining 25 years or until you pay off the loan.

How Do Floating Interest Rates Work?

Floating interest rates are typically tied to an economic index.

Your loan’s floating interest rate may be tied to the prime rate, the baseline rate consumers with good credit can qualify for. If the prime rate increases, your loan’s interest rate will likely climb. Other indexes, such as the federal funds rate, are also used by financial institutions. The prime rate may actually change based on the federal funds rate. It’s typically 3% higher than the federal funds rate.

Which index your lender uses will depend on the type of loan you apply for and your location.

Fixed Vs. Floating Interest Rates

Should you go for a fixed-rate or adjustable-rate loan when you apply for a mortgage? What you ultimate