# Floating Interest Rate: Definition, How It Works, and Examples

![Floating Interest Rate: An interest rate that periodically adjusts up or down to reflect economic or financial conditions.](https://www.investopedia.com/thmb/ffvUaavuCfgmjpfcI1Oz2QQcaUU=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/floatinginterestrate.asp-final-e149f1f9350543248c58a74e2f9ad3c5.png)

*— Investopedia / Julie Bang*

> **Definition**
>
> Unlike fixed interest rates, floating interest rates fluctuate over time based on market conditions or a benchmark rate

## What Is a Floating Interest Rate?

A floating interest rate is an interest rate that changes periodically. The rate of interest moves up and down, or "floats," reflecting economic or financial market conditions. Often, it moves in tandem with a particular [index](https://www.investopedia.com/terms/i/index.asp) or benchmark or with general market conditions.

Credit cards and some [mortgage loans](https://www.investopedia.com/the-best-mortgage-lenders-11714101) come with floating interest rates, also called adjustable or [variable interest rates](https://www.investopedia.com/terms/v/variableinterestrate.asp), because they can vary over the term.

### Key Takeaways

*   A floating interest rate fluctuates with market conditions, unlike a fixed (or unchanging) interest rate.
*   Credit cards and some mortgage loans come with floating interest rates.
*   Floating interest rates reflect the market by following an index or tracking another benchmark interest rate.
*   Floating rates—or variable rates—can increase a borrower's financial risk versus fixed rates since the monthly payment and interest cost can change.

## Understanding Floating Interest Rates

Many types of [loans](https://www.investopedia.com/how-to-get-a-personal-loan-7642254) and debt instruments carry floating interest rates, including credit cards and mortgages. A floating [interest rate](https://www.investopedia.com/what-is-the-average-personal-loan-interest-rate-8558877) rises or falls with the overall market or mirrors a [benchmark](https://www.investopedia.com/terms/b/benchmark.asp) interest rate.

The underlying benchmark rate or index depends on the type of [loan](https://www.investopedia.com/the-best-personal-loans-for-fair-credit-8764836) or security, but it is often either the [Secured Overnight Financing Rate (SOFR)](https://www.investopedia.com/secured-overnight-financing-rate-sofr-4683954), the [federal funds rate](https://www.investopedia.com/terms/f/federalfundsrate.asp), or the [prime rate](https://www.investopedia.com/terms/p/primerate.asp) (the interest rate financial institutions charge their most creditworthy corporate customers).

[Financial institutions](https://www.investopedia.com/articles/personal-finance/111815/6-biggest-banks-offering-personal-loans.asp) usually charge a [spread](https://www.investopedia.com/terms/s/spread.asp)  over the benchmark rate for consumer credit products like personal loans, [mortgages](https://www.investopedia.com/the-best-mortgage-lenders-for-bad-credit-11697459), car loans, or credit cards. The spread depends on several factors, including the type of credit or the consumer’s [credit rating](https://www.investopedia.com/terms/c/creditrating.asp). Thus, a [bank](https://www.investopedia.com/the-best-online-banks-11722209) might state the floating rate for a [loan](https://www.investopedia.com/the-best-secured-personal-loans-8763319) as “the SOFR plus 300 basis points" or "plus 3%."

> **Important**
>
> Floating interest rates may be adjusted quarterly, semiannually, or annually.

### Types of Floating-Rate Products

Home loans that carry floating rates are known as [adjustable-rate mortgages (ARMs)](https://www.investopedia.com/terms/a/arm.asp). ARMs have rates that adjust based on a preset margin (or spread) and a mortgage index such as SOFR, the [Cost of Funds Index (COFI)](https://www.investopedia.com/terms/1/cofi.asp), or the [Monthly Treasury Average (MTA)](https://www.investopedia.com/terms/m/mtaindex.asp).

For example, if an individual takes out an ARM with a 2% margin over the SOFR, and SOFR is at 3% when the mortgage's rate adjusts, the mortgage rate resets to 5% (the margin plus the index).

Most credit cards charge floating or variable interest rates on unpaid balances. The credit card agreement that new cardholders receive will state that the card's annual percentage rate (APR) is based on a particular rate or index plus a certain percentage (or margin). The agreement may include text such as "this APR will vary with the market."  

> **Fast Fact**
>
> Credit card interest rates are predominantly indexed to the prime rate, a rate set by individual banks, which can reflect the federal funds interest rate set by the Federal Reserve several times per year. Credit card companies then add to that rate a margin that varies at the card product level and according to an individual account holder's credit score and credit history.

## Floating Interest Rate vs. Fixed Interest Rate

A floating interest rate contrasts with a [fixed interest rate](https://www.investopedia.com/terms/f/fixedinterestrate.asp). With a fixed interest rate, the rate is constant and may apply to the entire loan term or debt obligation or just part of it.

[Residential mortgages](https://www.investopedia.com/the-best-va-loan-lenders-11697437) come with either fixed or floating interest rates. With fixed interest rates, the [mortgage interest rate](https://www.investopedia.com/mortgage-rates-5094943) cannot change for the duration of the mortgage agreement. With floating or variable interest rates, the mortgage interest rates can change periodically with the market.

For example, if someone takes out a fixed-rate mortgage with a 4% interest rate, the individual will pay that rate for the lifetime of the [loan](https://www.investopedia.com/emergency-loans-for-bad-credit-5075539), and the payments will be the same throughout the loan term.

In contrast, if a borrower takes out a [mortgage with a variable rate](https://www.investopedia.com/terms/v/variable-rate-mortgage.asp), it may start with a 4% rate and then adjust, either up or down, changing the monthly payments over the life of the loan.

## Example of a Floating Interest Rate Loan

Herbert and Amanda buy a house and take out a $500,000, 30-year 7/1 ARM. When they take out the loan, rates are low, and they initially get a 2% interest rate on the ARM.

For the first seven years, the loan's rate remains fixed at 2%. At the end of that time, the mortgage resets to a floating interest rate, which changes once a year. The floating rate tracks the SOFR.

*   In the eighth year, their loan's floating interest rate rises to 4%, reflecting the SOFR.
*   In the ninth year, the SOFR rate dropped slightly, decreasing their rate to 3.7%.
*   In the 10th year, the SOFR decreases again, pushing the couple's floating rate lower to 3.5%.

The interest the couple pays on the mortgage will fluctuate, and the rate will reset annually until they pay off the mortgage or [refinance](https://www.investopedia.com/best-mortgage-refinance-companies-5092956) the ARM to a fixed-rate mortgage loan.  

## Advantages and Disadvantages of Floating Rates

### Advantages

*   Floating-rate mortgages tend to have lower introductory interest rates than fixed-rate mortgages. As a result, the low introductory rate can appeal to some borrowers since it lowers the monthly payment and helps boost approval odds.
*   ARMs can appeal to those who plan to sell their property and repay the [loan](https://www.investopedia.com/the-best-personal-loans-for-bad-credit-8761245) before the rate adjusts or borrowers who expect their [equity](https://www.investopedia.com/terms/h/home_equity.asp) to increase quickly as home values rise.
*   Floating interest rates may float down, thus lowering the borrower's monthly payments.

### Disadvantages

*   The key disadvantage of a floating rate is that the rate may float upward and increase a borrower's monthly payments, even perhaps to the point of making those payments impossible.
*   The unpredictability of a floating rate [loan](https://www.investopedia.com/the-best-personal-loans-for-debt-consolidation-8762444) can make it challenging to budget cash flow and calculate the long-term borrowing costs.
*   Taking out a floating-rate credit product or [loan](https://www.investopedia.com/the-best-personal-loans-8761582) means you are at the mercy of market interest rates.

> **Advisor Insight**
>
> James Di Virgilio, CIMA, CFPChacon Diaz & Di Virgilio, Gainesville, FLWhen it comes to long-term borrowing, it is best to stay away from a floating rate or any type of variable loan, and this is particularly true when interest rates are very low. It is important to know exactly what your debt will cost you so that you can budget accurately without any surprises.When you choose to use a variable-rate loan, you are essentially gambling that interest rates will be lower in the future. Each year, a changing interest rate environment could bring a new and potentially higher interest rate, which could significantly increase the amount of interest you will have to pay.When rates are historically low, the odds are good that rates will increase in the future and not decrease, making a floating-rate loan a poor choice. Therefore, using a fixed-rate loan, especially in a low-interest-rate environment, is the wisest move.

## Which Is Better, a Floating or Fixed Interest Rate?

As a borrower, whether a floating or fixed rate is better depends on your financial situation and your outlook on interest rates. A floating interest rate can save you money if rates decrease. However, when rates rise, so does your payment, making financial planning and [budgeting](https://www.investopedia.com/the-best-budgeting-apps-11725751) challenging. So, floating interest rates pose a risk.

Conversely, a fixed interest rate provides a fixed monthly payment and peace of mind in a rising rate environment. However, your rate won't adjust lower in a falling rate environment.

## What Is An Example of a Floating Rate?

A floating rate represents a base rate that tracks a benchmark rate, such as the U.S. prime rate or SOFR, plus a margin above that base. So, if a [loan](https://www.investopedia.com/the-best-heloc-loans-11695646) or debt instrument has a floating rate tied to the SOFR plus a 6% margin, and SOFR is at 6%, then the floating rate is 12%.

## Do Credit Cards Have Floating Rates?

Yes, most [credit cards](https://www.investopedia.com/personal-finance/top-credit-cards-international-students/) have floating or variable rates that fluctuate according to the prime rate. The credit card company adds a percentage to the prime rate to determine the card's interest rate. For example, if the card issuer adds 12% to the prime rate of 8%, the customer pays a 20% rate on the credit card.

## The Bottom Line

A floating interest rate, otherwise known as a variable interest rate, fluctuates periodically in line with the benchmark rate to which it's pegged. As the benchmark rate increases, so does the floating interest rate, and vice-versa.

If a floating rate drops, borrowers will save money with lower monthly payments. However, if a floating rate rises, borrowers will pay a higher interest rate, pushing the monthly payment higher. The risk of higher borrowing costs represents the primary disadvantage of credit products with floating interest rates.

> **Article Sources**
>
> 1.  Federal Financial Institutions Examination Council. "[Methodology for Determining Average Prime Offer Rates](https://ffiec.cfpb.gov/tools/rate-spread/methodology)."
>     
> 2.  Board of Governors of the Federal Reserve System. "[What Is the Prime Rate, and Does the Federal Reserve Set the Prime Rate?](https://www.federalreserve.gov/faqs/credit_12846.htm)"
>     
> 3.  Consumer Financial Protection Bureau. "[For an Adjustable-Rate Mortgage (ARM), What Are the Index and Margin, and How Do They Work?](https://www.consumerfinance.gov/ask-cfpb/for-an-adjustable-rate-mortgage-arm-what-are-the-index-and-margin-and-how-do-they-work-en-1949/)"
>     
> 4.  Consumer Financial Protection Bureau. "[Credit Card Interest Rate Margins at All-Time High](https://www.consumerfinance.gov/about-us/blog/credit-card-interest-rate-margins-at-all-time-high/)."