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Floating interest rate credit lines allow you to borrow on an as-needed basis and only pay interest on the amount of the credit line that you're actually using. Having a floating interest rate on your credit line means that before you calculate the interest expense, you must calculate the interest rate.
Annual Interest Rate
Before you can figure the interest expense on your floating rate credit line, you need to figure the applicable interest rate because it changes. The interest rate is calculated by adding the interest rate index to the margin. The index is the rate the loan is tied to, such as the London Interbank Offered Rate, on the date the interest rate is adjusted. The margin is the amount that's added to figure the interest rate on your credit line. For example, say your the LIBOR rate is 4 percent and your margin is 2 percent. Adding 4 percent plus 2 percent gives you the annual interest rate of 6 percent on your credit line.
Periodic Interest Rate
After you've found the periodic interest rate, you also need to calculate the periodic rate -- unless you only make one payment per year. To figure the periodic rate, divide the annual rate by the number of payments per year. For example, if you make monthly payments on your floating credit line and the annual rate is 6 percent, divide 6 by 12 to find the monthly rate is 0.5 percent.
Calculating Interest Expense
To figure the interest expense for each payment period, multiple the periodic interest rate by your average balance. The average balance equals the sum of the balances on each day during the period divided by the number of days during the period. For example, say the balance was $20,000 for 20 days during the month and $14,000 for 10 days during the month. The average balance equals $18,000. If the periodic rate is 0.5 percent, multiply $18,000 by 0.005 to find the interest expense equals $90.
If you're only making interest payments on your line of credit, you're never going to pay off the loan because none of the payment goes toward the principal. At the end, you may be required to make a balloon payment. For example, you might have a home equity credit line that lets you make interest-only payments for 10 years, but at the end you have to pay off the entire balance in one fell swoop -- or pay to refinance the loan.
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