Fixed vs Floating Interest Rates on Business Loans

When you take a business loan, you usually choose between two kinds of interest rate:

• A fixed rate, which stays the same for the agreed period, so your payment never changes.
• A floating (variable) rate, which is set as a benchmark rate plus a margin and moves whenever the benchmark moves.

Neither is always better. The right choice depends on how much uncertainty your cash flow can handle, and how long you will have the loan.

How a floating rate is built

A floating rate has two parts:

Your rate = benchmark rate + lender’s margin

The benchmark is a market rate that the lender doesn’t control. Examples include SOFR in the US, SONIA in the UK, EURIBOR in the eurozone, BBSW in Australia, CORRA in Canada and KIBOR in Pakistan. Some banks use their own base or prime rate instead. The margin reflects your risk as a borrower and is usually fixed for the life of the loan.

The rate is reset at set intervals, often every 1, 3 or 6 months. Your payment changes at each reset.

What a rate change does to your payment

Here is a $200,000 loan repaid monthly over 5 years:

Each 1 percentage point rise adds about $100 a month, or about $6,000 over the full term. That may not sound like much, but on a $1 million loan it is about $500 a month. If your DSCR is already tight, that can be enough to break a covenant.

Try other amounts and rates in our EMI calculator.

Fixed rate: pros and cons

Pros

• Your payment is the same every month, which makes budgeting and forecasting easy.
• You are protected if rates rise.
• Lenders and investors see less risk in your plan.

Cons

• Fixed rates are often set a little higher than the floating rate at the start, because the lender is taking on the rate risk.
• Paying off early can trigger break costs or prepayment penalties, which can be large if rates have fallen since you borrowed.
• You don’t benefit if rates fall.

Floating rate: pros and cons

Pros

• It is often cheaper at the start.
• You benefit straight away if rates fall.
• Early repayment is usually cheaper and simpler.

Cons

• Your payments can rise, sometimes quickly. Many businesses saw this when benchmark rates rose sharply in 2022 and 2023.
• It is harder to plan cash flow for the next few years.
• Lenders may test your loan at a higher “stressed” rate before they approve it.

Which suits your business?

A fixed rate usually suits you if:

• Your margins are thin, or your DSCR is close to the lender’s minimum.
• The loan is for a long-term asset and you plan to keep it for the full term.
• You would rather have certainty than possible savings.

A floating rate usually suits you if:

• Your cash flow has a comfortable buffer.
• You expect to repay early, for example from a property sale or a planned refinance.
• The facility is short term, such as a line of credit, where floating rates are normal anyway.

Options in between

• Split loans. Part of the loan is fixed and part is floating.
• Rate caps. You pay floating, but there is a ceiling on the rate, usually for an upfront fee.
• Interest rate swaps. These are used for larger loans to turn a floating rate into a fixed one. They are complex contracts and can be expensive to exit, so take independent advice before you sign.
• Fixed for a period. The rate is fixed for, say, 2 to 5 years and then becomes floating or is re-fixed.

Questions to ask before you choose

1. What is the benchmark, how often does it reset and what is the margin?
2. Is there a floor? Some floating loans never go below a minimum rate even if the benchmark falls.
3. What would it cost to repay early under each option?
4. Can you switch from floating to fixed later, and on what terms?
5. Do any covenants depend on interest cover, and would they still be met if rates rose by 2 to 3 percentage points?

Run your own numbers: use our free loan comparison calculator to check your figures before you speak to your bank.

Sources and further reading

• State Bank of Pakistan: KIBOR rates
• State Bank of Pakistan: Laws and Regulations (Prudential Regulations)

This article is general information, not financial advice. Rates, products and terms differ between lenders and countries. Speak to your bank or a qualified adviser before you decide.

Related: the SME Loan Package Starter Kit calculates DSCR, ratios and repayment schedules in one Excel file.

Related guides

• Flat Rate vs Reducing Balance Interest: What a Business Loan Really Costs
• How Is a Loan EMI Calculated? The Formula, a Worked Example and the Flat-Rate Trap
• How to Read a Bank Term Sheet: 10 Terms to Check Before You Sign

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