What Are Floating Interest Rates? Know The Strengths, Weaknesses, And How To Calculate Them

Illustration of rising interest rates (Freepik)

YOGYAKARTA - Floating interest rates or floating rates are one type of interest rate in the Home Ownership Credit (KPR) system at conventional banks. Submission of mortgages with a floating rate refers to the prevailing reference interest rate. So, what is a floating interest rate?

An explanation of floating interest rates can be seen in the following article.

What is Floating Interest Rate?

A floating rate is an interest rate that always changes according to interest rates on the market, as compiled by VOI from various sources, Monday, January 16, 2023.

An example is the mortgage interest rate for a certain period. For example, for the first two years a fixed interest rate is applied, but the following period uses an expanding interest rate.

The application of this KPR interest rate product causes the nominal that must be paid by the debtor not as high as the usual interest rate and will be released to the borrower after the interest rate period ends.

Floating interest rates set by banks can continue to change during the loan term. This is influenced by Bank Indonesia's benchmark interest rate or the BI 7-Day Reverse Repo Rate (BI7DDR).

Thus, when the BI rate rises, mortgage interest rates also increase. Conversely, if the BI interest rate falls, then the entire burden of installment payments borne by the debtor will also decrease.

Advantages and Disadvantages of Floating Interest Rates

Floating interest rates have several advantages, including:

• Lenders never charge interest far above the average reference rate.
• The installment burden borne by the debtor has the potential to decrease if market rates fall.
• Floating interest rates are suitable for risk-taking buyers, such as entrepreneurs and high-income private employees.

While the disadvantages of floating rates are:

• Interest rates always change according to market interest rates
• Installment costs have the potential to be greater if Bank Indonesia increases the BI7DRR or the benchmark interest rate

From the advantages and disadvantages of the floating rate above, it can be concluded that customers who wish to take a mortgage must have a reserve fund so that they can cover billing costs if at any time the interest rates increase.

How to Calculate Floating Interest Rates

Illustration of mortgage loan (Photo: Pixabay/anncapictures)

As mentioned above, the floating rate on mortgages is floating, meaning that it can change according to the rise and fall of interest rates on the market.

This condition causes the installment value that must be paid each month to change.

Therefore, this mortgage interest rate product is perfect for those of you who can take financial risks.

The floating rate calculation formula is:

Interest = Loan Principal Balance (SP) x Annual Interest Rate (i): 12 (number of months in a year).

For example, let's say you want to apply for a house mortgage worth Rp. 500 million with a tenor of 10 years.

In the process, fluctuating interest is set at 10 percent, with an installment period of one to three years. Then, it rose to 12 percent in the fourth year onwards.

The amount of installments you have to pay for the first three years is:

IDR 500,000,000 x 10 percent x 3 :36 = IDR 4,166,666

In the fourth year, the installment amount will increase to IDR 5 million due to an increase in interest rates of 2 percent from the previous. The calculations are as follows:

IDR 500,0000,000 x 12 percent x 3 : 36 = IDR 5,000,000.

The calculation above is only an example. What you need to underline is how to calculate mortgage installments with a floating system according to interest rates on the market.

This is information about what floating interest rates are along with their advantages, disadvantages and how to calculate them. May be useful!