Adjustable Rate Loans

In a floating-rate loan (also called an adjustable-rate loan), the interest rate varies over the term of the loan.

The formula by which such a rate is calculated is specified in the contract in advance. It also sets the conditions: how often the bank will revise the interest and on what it will depend.

The following can be “adjusted”:

  • monthly payment. That is, when the rate rises, the total cost of the loan also increases. And in order to pay it off at the same time, the borrower has to increase monthly spending;
  • the term of the loan. That is, if the borrower wants to pay the same amount every month as before, then he or she will have to do it longer.

There are also combined options.

Do banks give adjustable-rate loans to anyone?

As a rule, adjustable-rate loans are issued to corporate clients – legal entities or individual entrepreneurs.

And although the law does not prohibit issuing adjustable-rate loans to individuals, banks almost do not do it. According to statistics 2021, the share of debt on adjustable-rate loans in the portfolio of US credit institutions is less than 0.1%.

Adjustable rate vs fixed rate

When issuing loans, banks have to take into account:

  • credit risk – the risk that the borrower will be in an unfavorable situation and will not be able to repay the debt;
  • interest rate risk – the risk of financial losses that arise due to changes in interest rates.

Accordingly, an adjustable rate enables banks to quickly respond to changes in the economic situation and share part of the interest rate risk with the borrower.

On the other hand, credit risk increases. After all, if the interest rate rises, the borrower runs the risk of not coping with the increased payments.

Isn’t a fixed rate more beneficial for clients than adjustable?

Much depends on the situation in the economy and the behavior of the indicator to which the adjustable rate is tied.

If the key rate goes down and there is a forecast that it will go down further, but the interest on the loan remains the same, it turns out that the borrower is overpaying. With an adjustable rate, if the indicator goes down, the borrower saves on interest.

During periods of economic stability, an adjustable rate makes a loan cheaper. After all, when a bank issues a fixed-rate loan, it expects how the key rate will change in the near future. Will grow? Then the fixed rate will be higher than the current floating ones. Will decrease? Then below.

In addition, an adjustable-rate loan would be suitable for someone who is going to repay the debt as quickly as possible. Example. The borrower plans to sell one apartment and buy another. The easiest way is to first sell and buy real estate with the money received. But what if the time to buy is limited and the sale of your existing home is delayed? Then the borrower could take out an adjustable-rate mortgage, which would most likely be lower than the fixed rate, sell the main apartment and pay off the debt relatively quickly.