In a floating-rate loan (also called a variable-rate loan), the interest rate varies over the term of the loan.
The base interest rate for a floating-rate loan is the prime rate based on the Bank of Canada’s overnight rate. The lender negotiates an additional percentage of interest above the prime rate to cover its risk in lending the money (for example, prime plus 3%).
Because the prime rate can change, the loan is variable. This means that if the prime rate goes up, the interest rate that has to be paid by the borrower also increases. The additional amount, called spread-to-prime (prime plus 3%), does not typically change over the term of the loan unless there is a change in risk for the business, in which case it could be renegotiated.
Usually the term of the loan and its amortization period (payback schedule) are the same. Payments may be weekly, bi-weekly or monthly. They may also be blended, principal + interest or balloon payments.
The advantage of floating-rate loans is that lump-sum payments of principal can be made at any time without penalty—meaning a borrower can accelerate paying off the loan. However, because most floating-rate loans are demand loans, the lender can also “demand” repayment in full at any time (though not likely if the loan is being repaid as agreed).
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