Floor Rate

Full definition

A floor rate is a contractual minimum rate on a variable-rate loan. It prevents the borrower's interest rate from falling below a specified level even if the index rate (Prime Rate, SOFR, etc.) drops significantly. How it works: A variable-rate personal loan with a rate of Prime + 5% and a 6% floor rate: if Prime is 7.50%, rate = 12.50%. If Prime falls to 4%, rate would normally be 9%, but the floor prevents it from going below 6%, so the rate stays at 6% even though Prime + 5% would be 9%. Wait - in the example above, 9% is above the floor of 6%, so the floor is not triggered. A floor only matters when the index plus margin calculation falls below the floor. Example where floor matters: floor rate of 8%, Prime falls to 2%, Prime + 3% margin = 5%, which is below the 8% floor, so rate stays at 8%. When floors appear in personal lending: Floor rates are more common in commercial and mortgage lending than in consumer personal loans. Variable-rate personal loans (already uncommon) sometimes include a floor to protect the lender from extremely low rate environments. In the 2020-2021 near-zero rate environment, some lenders' variable rate products hit their floor rates. Borrower implication: A floor rate limits the downside protection of variable-rate borrowing. One of the benefits of variable rates is that they decline when central banks cut rates. A floor caps that benefit. Check for a floor rate when evaluating any variable-rate personal loan.

• Variable Rate
• Rate Cap
• Prime rate
• Index Rate