Interest has always been a deciding factor when it comes to selecting a cost-effective funding option or a profit-earning investment scheme. However, besides the interest amount earned, the adjoining rate also plays a vital role in making a favourable decision. With that being said, individuals must make it a point to find more about interest types like – floating rate and fixed rate to make an informed decision.
Following is an elaboration of the fundamentals of floating interest rate meaning for investments.
The floating rate meaning suggests that it is an interest rate that tends to fluctuate with the market or on an index. The fact a floating interest rate may vary during the time horizon of an investment or debt tenure has earned it names like – variable, flexible or adjustable interest rate.
Notably, a change in floating interest rates depends entirely on a ‘benchmark’ or a reference that is beyond the control of the parties involved in an investment. This particular reference rate is a standard benchmark like the – prime rate. In case of floating rate on loans, the said benchmark is the lowest possible rate that commercial institutions levy on creditworthy borrowers.
When compared to fixed-rate debts, credit options that come with floating rates are relatively cost-effective in the long run, even though they depend on the yield curve. On the other hand, in case of investments with floating rates, individuals can generate stable and predictable returns on them over time.
It must be noted that several factors tend to influence the calculation of floating interest rates. Some of the economic factors are given below –
Since the rate of this type of interest is susceptible to changes, the calculation can often be dubious. This is why it is better to calculate floating interest rate with the help of an investment or a loan EMI calculator.
Individuals can understand the relevance of floating rate under these situations –
Typically, intending borrowers pick a loan with a floating rate when they expect a reduction in the interest rate or a dynamic rate through their loan tenure. Additionally, such an interest type enables individuals to make prepayments easily and pay off their debt faster and at a much lower interest burden.
Individuals can choose investment instruments with floating rates when they anticipate the base rate will be the same, or an expected change will be in their favour. Under such situations, the interest earned on investments made either stays the same or is likely to increase. Nonetheless, individuals must make it a point to weigh the benefits of the variable interest rate to decide whether it will help them to save or earn more over time.
These following pointers highlight the major advantages of a floating interest rate –
For loan borrowers
Regardless, certain limitations accompany this type of interest rate and must be accounted for to make way around them.
Typically, these following drawbacks of floating rate limit its scope –
|The interest rate may fluctuate throughout the loan tenure or investment horizon.||The rate of interest remains the same throughout the loan and investment tenure.|
|The fluctuations tend to influence the EMI amount and returns on investment.||The loan EMI remains fixed throughout.|
|Those who do not mind adjusting their budget and financial plan may be comfortable with this type of interest.
Also, borrowers who wish to pay off their loan quickly and at zero prepayment charge often prefer this rate of interest.
|Those who follow budgeting and are comfortable with a fixed instalment schedule may find fixed interest investment suitable.|
To make the most of their investments or to manage their debt more conveniently, individuals must weigh in the pros and cons that accompany each interest type and proceed accordingly. They should also gauge the efficiency of their financial management plan and budgeting prowess before selecting a floating rate or fixed rate of interest.