You borrowed money from a bank. Your stated floor rate is 4.5%. That's the lowest rate you can pay for having borrowed money to buy Betsy, your used army jeep with pink rims with 22,000 miles. But the ceiling rate you'll pay until you pay her off is 6.25%. Your rate floats as LIBOR plus 100 basis points, and with LIBOR at 3.5% today, you're just at your floor. If LIBOR goes lower, you'll still pay the 4.5% floor rate, even though with LIBOR at, say, 3.2%, you're 130 basis points over for your floor.
That's the interest rate collar on the low side. Then, on the high side, if LIBOR shoots to 6% and you'd owe, un-collared, 7% interest, you won't have to pay it, because your ceiling is 6.25%.
That's how collars work, and they're great for people who can afford interest charges within a range but not a cent more.
And we'll save our normal Fifty Shades joke on this one.
Related or Semi-related Video
Finance: What is interest?20 Views
finance a la shmoop. what is interest? well you know how common the catchphrase
that's interesting is used? why well because something of interest is something of [man stands in theme park]
value. right if it's interesting it's valuable to know. yeah that's where the
notion of interest came from. so financially speaking the thing of value
you have is your capital- your money- the dough you saved from mowing lawns all
summer. and you can use that capital to make more capital for yourself without
having to you know mow more lawns. all right well how do you pull off this
magic? you invest your money and one interesting way to invest it in is in
bonds, which conveniently for this video pay interest. well interest is just rent
on the money you're loaning someone. and when you buy a bond you are the landlord,
right you're renting out your money to someone else, that is people will pay you
say 60 bucks a year to rent a thousand dollars from you the rate they're paying [kid rents money from a stand]
then is 6% a year to rent that lawn-mowing grant. and if you were buying
a formal publicly traded bond like the ones offered by say ATT or Comcast or
Time Warner and others, well you'd be paid your interest twice a year. that is
you'd get 30 bucks on June 30th and another 30 bucks just before New Year's
Eve, just in time to buy a bunch of those obnoxious noisemakers. and you'd collect
that interest until the bond says it'll pay you back your original amount called
principle. so if this were a ten-year bond paying 6% interest well your
little journey and renting your grand to AT&T would look like this - see you got
June 30 2020 collect 30 and then it goes December and during the design it goes I [interest shown on document]
don't know until you collect your thousand bucks. got it?
note how much interest you made from the grand you invested in that 6% bond. you
did nothing for 10 years just sitting on your fat butt watching the Cleveland
Browns lose football games, and you collected 30 dollars 20 times for a
total of 600 bucks in total interest, and then you got your grand
back. 600 bucks for doing well pretty much nothing a concept with which the
Cleveland Browns are oh so familiar. [man sleeps on couch holding cash]
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