Understanding Floating and Fixed Interest Rates: Should You Swap?

By: Tom Jordan, Central PA Market President, Univest Bank and Trust Co.

Interest rates are currently at record lows due to the Federal Reserve’s response to COVID-19 and will likely stay low until the U.S. has recovered economically from the pandemic. With such low rates, business owner borrowers may want to consider an interest rate swap if they are looking for a low, long-term fixed interest rate.

Fixed rate vs. floating rate
A fixed rate is an interest rate that will not change for the duration of a loan agreement. With this type of loan, businesses are immune to changing interest rates by settling on a long-term, fixed interest rate. For example, individuals who take out a loan with a 4% interest rate will pay this rate for the entire loan period and their payments will stay the same for the duration of the loan.

A floating rate is based on an index such as the London Inter Bank Offered Rate (LIBOR), or the Prime rate which is set by the Federal Reserve. One of the potentially attractive qualities about floating rates is that it’s a market-traded rate. This means the rate can float up or down depending on inflation and index movements which in turn impacts monthly payments on loans.

A floating rate will adapt to economic changes like we have seen in the past few years with the pandemic and economic turmoil, where a fixed rate will not. If a business owner with a fixed rate looks back over the last 10 years, they may find he or she could have potentially saved money in the long-term by utilizing a floating interest rate.

What is a rate swap?
Interest rate swaps allow businesses to exchange a floating rate for a fixed rate. Swaps might be ideal for borrowers with loan opportunities over $1,000,000 who are planning on holding the asset for the loan term and who are looking for construction-to-permanent financing, refinances or purchases financing. Some business owners might complete a rate swap with the goal of reducing exposure to fluctuating interest rates.

Is your business eligible?
Businesses must be Eligible Contract Participants to swap rates. There are multiple criteria to become an Eligible Contract Participant, such as having total assets that exceed $10,000,000, or multiple business owners with a combined net worth of $1,000,000. It’s important for business owners considering a swap to work closely with their lender to both ensure they meet one of the criteria to become an Eligible Contract Participant and decide if a rate swap is right for them. Understanding fixed vs. floating interest rates can help business owners ultimately maximize financial security and minimize potential costs.

In the current economic environment and with Federal interest rates at an all-time low, now may be a time to consider an interest rate swap. It’s important for business owners to understand how it works and how they could benefit the business and potentially save money in the long-
term. Interested in learning more about how interest rate swaps could work for you and your business? Univest is here to help. Contact us to begin a conversation.

Univest Bank and Trust Co. is Member FDIC, Equal Opportunity and SBA Preferred Lender.