Floating Rate
Interest that is revised according to the market conditions is called as Floating rate of interest. It is also called as variable interest rate or adjustable rate. In this case the interest rate will fluctuate depending on various factors in the market like inflation, tax rates, liquidity etc. There will be a fixed base rate, which is also called as bench mark rate. An extra rate of interest is added along with base rate according to fluctuating conditions. In rare cases this extra rate might be subtracted from base rates.
Time period
A time period is fixed in order to revise the rate of interest. Most of commercial loans make use of floating interest, whereas as personal loans follow the fixed rate of interest. But in countries like US, Canada both floating as well as fixed loans are in favor of borrower. In Indian context most of business loans are provided for floating rate of interest with a revision time period of 3, 6, 9 or 12 months. Sometimes in mortgage loans floating rates might be used, which often has a tenure of more than 20 years, where the revision time will be in each 4 or 5 years.
Example
Ramesh took a commercial loan of Rs.50000 from a bank at base rate of 2%. Floating rate will be revised every 6 months. For the first 6 months the floating rate will be 3.5%, thus the annual interest accounted to be 5.5% (2+3.5). Thus he need to pay Rs.1375 towards interest for first 6 months. The revised floating rate for second half was 4.5%, now the annual interest will be 6.5% (4.5+2), thus he needs to pay Rs 1625 towards interest. Whereas for the third half, the floating rate fell from 4.5% to 1.5% thus revised rate for next 6 months will be 3.5% i.e. Rs. 875.
