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A Quick Intro To The Floating Interest Rate

Dan Rafter6-minute read

November 17, 2021

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You’ll make plenty of big decisions while buying a home, from choosing a real estate agent and picking the right neighborhood to determining which home is the best fit for you. Another big decision, and one of the most important financial choices you’ll make, is choosing the right mortgage.

When you apply for a mortgage loan, you can choose from a wide variety of options. You might choose a shorter-term mortgage, such as one that you can pay off in 10 or 15 years, or a longer-term loan that can take 30 years to pay off.

This includes whether to choose a home loan with a fixed or floating interest rate.

What Is A Floating Interest Rate?

A floating interest rate changes throughout the life of your loan. You might take out a loan in which your mortgage interest rate is 3.5% for the first 5 years of its term. The rate might then adjust – or float – once every year for the rest of the loan’s life.

Unlike a floating interest rate, a fixed interest rate doesn’t change throughout the life of your mortgage. If you take out a 30-year fixed-rate loan with an interest rate of 3.9%, that interest rate will remain at 3.9% for the life of your loan.

Floating interest rates are typically tied to different economic indexes. Your loan’s floating interest rate might be tied to the prime rate, which is the best interest rate consumers with good credit can qualify for. If the prime rate goes up, your loan’s interest rate might rise, too, during the floating period of your mortgage.

Floating interest rates are also common with credit cards, where they are referred to as variable interest rates. With mortgages, they are most often seen with adjustable-rate mortgage loans, loans in which the interest rate remains fixed for a set number of years – often 5 to 7 – and then adjusts typically once or twice a year throughout the remainder of the loan’s term.

A floating interest rate does bring some risk: Your interest rate could rise higher throughout the term of your loan, possibly straining your budget as this higher rate causes your monthly mortgage payments to increase. With a fixed interest rate, you’re more certain how much you’ll pay each month on your mortgage, though your mortgage payment can vary slightly depending on your home’s property taxes and homeowners’ insurance.

There is some protection built into floating-rate loans, though. Generally, the interest rates with adjustable-rate mortgages can only rise to a certain level, a ceiling put in place by your lender.

Today's Purchase Rates

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Fixed Vs. Floating Interest Rate

When you’re applying for a mortgage, should you go for a loan with fixed rates or one with a floating or adjustable interest rate? That depends on your goals.

The benefit of an adjustable-rate mortgage with floating interest rates is that you’ll save money during the earlier years of your loan. Adjustable-rate mortgages during their early years typically offer interest rates that are lower than what you’d get with a fixed-rate loan.

Before an adjustable-rate mortgage’s interest rate starts the adjustment period – typically 5 to 7 years – homeowners can save significant money.

The challenge starts after an adjustable-rate mortgage’s fixed period ends. That’s when these loans’ floating interest rates change, rising or falling once or twice a year depending on whatever economic index it is tied to. In most cases, the floating interest rate will rise after the fixed period ends, meaning that homeowners’ mortgage payments will increase, too.

Many homeowners take out adjustable-rate mortgages when they plan on moving after a short time, before the fixed period of their loan ends. Others plan on refinancing their adjustable-rate mortgages into fixed-rate loans before the fixed period ends.

There is a risk here, though. What if home prices fall? You might not be able to refinance an adjustable-rate mortgage because you might not have enough equity in your home if its value has fallen. And what if your plan to move changes or you can’t find a seller for your home? Your adjustable-rate mortgage might switch to its variable-interest-rate stage.

That’s why it’s important to make sure you can afford your monthly mortgage payment even after it leaves the fixed period. Know there is room in your budget for a higher mortgage payment in case you can’t refinance or move when you plan.

These challenges are why most homeowners gravitate toward fixed-rate mortgages. With a fixed interest rate, your monthly mortgage payment won’t fluctuate much over the life of the loan. This makes it easier to budget for your mortgage payments.

When A Floating Rate Might Be The Right Option

When does a floating interest rate make sense?

You plan to move in the next few years: An adjustable-rate mortgage with a floating interest rate makes sense if you plan on moving after just a few years. That way, you can sell your home and get out of your mortgage before the floating-interest period begins.

This gives you the chance to take advantage of the lower initial interest rate. Just be warned: If you can’t sell your home, your loan might move to its adjustable period before you get the chance to move.

You’re purchasing a starter home: Many buyers still purchase starter homes – homes that they only plan to live in for a few years. The goal is to build equity in that house and then sell it for a profit before moving to a larger home.

Again, taking out a loan with a floating interest rate might make sense if you only plan on living in your starter home for a few years before selling, moving and applying for a new mortgage.

Interest rates are higher than usual: If mortgage interest rates are high, you might consider an adjustable-rate mortgage. That way, you’ll get a lower interest rate than you would with a standard fixed-rate loan.

You can then refinance your adjustable-rate mortgage once mortgage interest rates fall again. Of course, there is some risk here: Rates might not fall. And if your home value falls, you might not have enough equity to close a refinance.

What Types Of Mortgage Loans Does A Floating Rate Apply To?

Consumers can apply for several types of mortgage loans when they’re ready to finance the purchase of a home.

Conventional Loans

Conventional mortgage loans are ones not insured by a U.S. government agency. Consumers apply for these loans with private mortgage lenders or financial institutions, and always have the option to apply for a fixed-rate mortgage or an adjustable-rate loan.

FHA Loans

FHA loans are insured by the U.S. Federal Housing Administration. These loans are attractive because they require down payments of just 3.5% of a home’s purchase price for borrowers with a FICO® Score of 580 or higher. Borrowers have the option of applying for an adjustable-rate mortgage when taking out an FHA loan.

USDA Loans

USDA loans are insured by the U.S. Department of Agriculture. These loans require no down payment at all, though borrowers must buy a home in a part of the country that the USDA deems rural. Borrowers can’t apply for an adjustable-rate mortgage if they want a USDA loan; Instead, they must apply for a loan that comes with a fixed interest rate.

VA Loans

VA loans are insured by the U.S. Department of Veterans Affairs and are only available to members or veterans of the U.S. Military or their widowed spouses. VA loans also require no down payment. Borrowers can apply for an adjustable-rate mortgage through this program.

Jumbo Loans

Jumbo loans are used to finance the purchase of more expensive homes, ones that cost more than the FHA's conforming loan limit. For 2021, any single-family home costing more than $548,250 in most parts of the country require jumbo loans.

In higher-cost areas of the country – such as Los Angeles –  homes costing more than $822,375 require jumbo loans. Because they’re so large, jumbo loans often require higher down payments. Jumbo loans are available as adjustable-rate mortgages.

The Bottom Line on Floating Interest Rates

Floating interest rates can leave you with smaller monthly mortgage payments, but this financial relief is only temporary. Adjustable-rate mortgages don’t keep those low mortgage rates forever. Make sure before applying for one of these loans that you can afford your monthly payments once those floating interest rates enter their adjustment periods.

Visit our Learning Center to learn more mortgage basics. If you’re ready to get started, you can apply online with Rocket Mortgage®.

Today's Purchase Rates

Loan Option Rate / APR
30 Year Fixed* 3.125% / 3.369%
15 Year Fixed* 2.375% / 2.807%
VA 15 Year* 2.25% / 2.903%
VA 30 Year* 2.625% / 2.982%
FHA 15 Year* 2.125% / 3.358%
FHA 30 Year* 2.49% / 3.431%
These rates are current as of 12:47 PM UTC on December 2, 2021

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Dan Rafter

Dan Rafter has been writing about personal finance for more than 15 years. He's written for publications ranging from the Chicago Tribune and Washington Post to Wise Bread, RocketMortgage.com and RocketHQ.com.

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