How to Calculate Floating Interest Rate?

If you've ever taken out a home loan, you've probably heard the term "fixed interest rate." Before telling you how to calculate floating interest rate, let me tell you about this rate. A floating interest rate, also called a variable interest rate, changes over time based on an external benchmark or reference rate. You can calculate this interest rate by adding the base rate with the spread.

Floating Rate Calculation Process

The floating interest rate is usually expressed as:

Floating Interest Rate = Base Rate (or Benchmark Rate) + Spread/Margin

Base Rate/Benchmark Rate: This is a reference rate set by the bank or an external authority. The following are common benchmarks in India.

• RLLR (Repo Linked Lending Rate): Tied to the RBI's repo rate.

• MCLR (Marginal Cost of Funds-based Lending Rate): Determined internally by banks.

• T-Bill Rates: Linked to Treasury Bill yields.

Spread/Margin: This is an additional fixed percentage set by the lender based on factors like credit profile, loan amount, and tenure. Throughout the loan duration, it stays the same.

Let’s understand it with an example.

• If the repo rate (RLLR) is 6.5% and the bank's spread is 2%, the floating rate = 6.5% + 2% = 8.5%.

• If the RBI changes the repo rate to 6.75%, the floating interest rate will adjust to 6.75% + 2% = 8.75%.

I hope you found this helpful.

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I learned how to calculate floating rate of interest when I took out a home loan for my first property. It is calculated by adding the base rate with the spread. This computation is essential to comprehending the possible expenses and risks of taking out a loan for a home. Let’s understand this from the below example.

How is Floating Interest Rate Calculated?

Start by finding the reference rate that the floating rate is based on. This could be a benchmark like the Treasury Bills, The Federal Funds Rate, and the London Interbank Offered Rate (LIBOR). 

Then, proceed with finding the margin which is the extra percentage added to the reference rate to get the final interest rate. The borrower's creditworthiness is one of the important aspects that the lender often considers while determining this margin.

Finally, find out the floating interest rate by adding the margin and the reference rate. You can look at the below example:

When the LIBOR is at 6% and a certain debt instrument has a floating rate that is dependent on the LIBOR plus a 6% margin, then the floating interest rate will be 12%.

Moreover, you can also go through the example described by Ana above. Unanticipated profits could always be achieved when interest rates are floating. It is always advantageous to have a floating interest rate on a home loan. This will guarantee that the borrower pays less interest in the case that interest rates decline. I hope now you have an idea of how to calculate floating interest rate for home loan.

In home loan, a

floating interest rate means the interest rate that can change in the course of the home loan tenure. The floating rate is highly dependent on the current market conditions. If the market rate changes so will the floating rate of the interest rate. Since the interest rate varies in floating rate, therefore the floating rate is also called the variable rate. This is what floating interest means.

How to calculate floating interest rate?

The floating interest rate depends on various factors such as:

• Repo Rate

• Government’s monetary policies

• Inflation rate

• Fiscal deficit

• Global and Foreign range

Since the floating rate can fluctuate depending on these factors it is hard to calculate the floating rate. But I will share the formula so that you can understand

how floating interest rate works.

To calculate floating rate you must know its history. Normally, the standard benchmark of borrowing has been LIBOR. The full form of LIBOR is “London Interbank Offered Rate”.

The formula to calculate the floating rate is based on:

• Base Rate (e.g. LIBOR)

• (+) Spread

Let’s say LIBOR is at 150 basis points and the senior loan’s interest rate is “LIBOR + 400”. So, the interest rate can be equal to 5.5%.

I will show the LIBOR calculation example:

• Floating Interest Rate = LIBOR + Spread

• Floating Interest Rate = (150 / 10,000) + (400 / 10,000)

• Floating Interest Rate = 1.5% + 4.0% = 5.5%

You must know LIBOR is getting replaced by  Secured Overnight Financing Rate (SOFR). In fact, it is anticipated that LIBOR will no longer be in effect by 2024.

I hope you understand now what floating interest rate means.

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