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Finance: What is the difference between a fixed and floating rate? 6 Views

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Description:

When issuing debt, the interest rate can be structured as a fixed rate, meaning the same coupon percentage annually due for the life of the outstanding loan, or a floating rate. The floating rate will often be based on a benchmark rate, such as LIBOR or a US Treasury of approximately the same maturity, along with a risk premium. The reason for the floating rate loan can be based on such factors as the lender anticipating that rates will rise in the future, thus creating a greater future return; the borrower conversely anticipating that future rates will drop, making subsequent payments less expensive, to negotiations over current liquidity, collateral, and other criteria.

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Transcript

00:00
Finance allah shmoop what's the difference between a fixed and
00:05
a floating rate All right well we'll just start this
00:09
one out with your favorite time Donald and melania need
00:17
to borrow money to buy a building here's the history
00:20
of ten year t bill costs for the last few

00:23
decades Well rates were almost ten percent in the nineteen
00:26
seventies and then they fell all the way to being
00:29
almost free in two thousand eighteen Well if donald had
00:34
borrowed money nineteen eighty to buy a building with us
00:37
fixed rate he'd have had to pay about ten percent
00:40
interest for all this time That raid in nineteen eighty
00:44
was fixed and you know i'd be paying ten percent
00:47
for thirty five years very expensive rent on that money
00:50
It's not like a dog who can't you know have
00:52
pups different kind of fixed you know it's fixes in
00:55
he won't move Position is just a set number fixed
00:59
in place All right well donald would have overpaid massively
01:02
in his loans by paying ten percent interest when he
01:05
could have been paying seven percent here and four percent
01:09
here And maybe like two percent change here if the
01:12
loan he'd taken out in nineteen eighty was floating well
01:15
it would have floated downward along the way like that
01:18
Well most for floating loans have a preset set of
01:22
terms which move along with the rates of the fed
01:24
charges to loan money to banks who then mark up
01:27
the loans a bit and resell the money to really
01:29
borrowers like donald and kill you and me That is
01:32
the floating rate might be set at quote the average
01:36
federal funds rate plus ah hundred faces points over the
01:40
trailing six month period to be reset every month Unquote
01:45
Yeah something like that So in this case his rate
01:47
would have floated downward And obviously things can go the
01:50
other way as well Joe six pack it's a mortgage
01:53
for a home he can barely afford today Eight hundred
01:56
grand mortgage at four percent Well it cost him thirty
01:59
two grand a year to rent that money just the
02:02
interest and he has to make principal payments as well
02:04
So is total payments or something like forty grand a
02:06
year in year one of thirty Well if rates go
02:09
back up and they easily could and become say seven
02:13
Percent instead of that four percent a few years later
02:16
three four five years later Well then all of a
02:18
sudden his cost of renting that money goes from thirty
02:21
two grand a year in interest costs too something like
02:24
fifty or sixty grand a year in interest costs And
02:27
joe six pack because he didn't fix his raid at
02:30
that four percent figure when he borrowed it let things
02:33
float and well he ended up you know living in
02:37
his car when he couldn't afford paying The mortgage owns
02:40
home anymore and had to sell it And so yeah
02:42
he's living in his suv down by the river But 00:02:45.5 --> [endTime] luckily for him that suv floats
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