Fixed vs Floating Rate on a Business Loan
The question is not where rates are going. It is how much of a rise your cash flow can carry, and who should hold the risk of the rest. Here is how a desk reads it, and how to decide.
BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED
// THE SHORT ANSWER
Fixed or floating is a risk allocation, not a prediction contest. A floating rate moves with the market both ways and leaves the business carrying a rise; a fixed rate hands that risk to the bank for a period, at a price, and gives up the freedom to repay without a break cost. A credit desk decides by cover: run it at today's rate and at a higher one, and if the gap would breach the covenant the risk belongs with the bank. Fix the part of the debt that will certainly still be there for the whole period; leave floating what you may repay.
BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.
// BEFORE THE BANK READS IT
The first checks a credit desk runs — is the growth real, does EBITDA convert to cash, are suppliers carrying the gap — on twelve numbers from your own accounts, with the senior banker's written read. Free, no signup, no data stored.
// 01 — WHAT EACH ONE IS
A floating rate is two things added together: a base rate the bank does not control, which moves with the market and resets on a schedule, and a margin the bank does control, set from the risk it sees in your business. When the base moves, your interest bill moves with it, in both directions. How Banks Price a Business Loan is about the margin; this page is about the base, and who carries its movement.
A fixed rate locks the whole rate for a period — shorter than the loan, or the same length. The bank funds or hedges that money at a fixed cost for the same period, which is why it can offer certainty, and why leaving early costs something. At the end of the fixed period the loan reverts to floating or is fixed again at the rate of the day, which is a date worth having in the diary, because a business that forgets it discovers the new rate on a statement.
// 02 — WHAT YOU ARE ACTUALLY BUYING
Not a bet. Fixing is buying insurance against a rise, and paying for it in two currencies: a fixed rate is often, though not always, set above the floating rate of the day, and it takes away the freedom to repay cheaply. Floating is declining the insurance and carrying the risk yourself, in exchange for the market's rate and the freedom to repay or refinance without a break cost. If rates fall after you fix, you did not lose a bet; you paid for cover you did not need, as with any insurance. If they rise after you float, you were not caught out; you chose to carry the risk and it arrived. The decision is only wrong when the business could not afford the outcome it chose to carry — which is the desk's test, and should be yours.
// 03 — THE COSTS THAT ARE NOT THE RATE
Floating · a rise in the interest bill that arrives without warning · cover that thins as the base rate climbs · a covenant tested at a rate you did not budget
The break cost is the one borrowers meet by surprise. It is set by the contract, calculated from where market rates have moved since the fix, and it can be nothing or a great deal — Refinancing and Switching Banks puts it beside the other costs of leaving, and Pricing and Fees beside everything else you pay. Read the clause before you fix. The floating rate's hidden cost is quieter: the bill rises, the interest cover covenant in the facility letter is tested on the new bill, and a business that was comfortable at the old rate finds itself in a conversation about headroom it did not expect.
// 04 — HOW THE DESK READS IT
A credit analyst does not ask which rate you prefer. They calculate cover at today's rate, then again with the interest bill higher — a sensitivity every paper on a floating-rate facility carries — and read the gap. A business whose cover is comfortable in both runs can float or fix as it likes. A business whose cover is comfortable today and thin at a higher rate is carrying a risk it may not have chosen, and the desk will say so: sometimes as a recommendation, sometimes as a condition of approval that a share of the debt be fixed or hedged for a period. The equipment finance file shows the other side of the same reading — an asset with a fixed earning life is commonly financed at a fixed rate, because its cash flows do not rise with the market either.
The bank's own interest rate risk is not in your loan. Its treasury funds and hedges the balance sheet whichever way its borrowers choose, which is why the desk is largely indifferent to your choice and entirely interested in whether your cash flow survives it.
// 05 — WHAT TO FIX, AND WHAT TO LEAVE
The rule most desks apply: fix the part of the debt you are confident will still be there for the whole fixed period, and leave floating the part you may repay, refinance or reduce. A term loan on a long-lived asset is the natural candidate for fixing — the asset's earnings do not rise with rates, so neither should its cost. A line of credit floats by nature: it has no fixed balance to fund, and an overdraft is repayable on demand and priced daily. A balloon you intend to refinance at maturity, or a loan you may repay from an asset sale, is the part to leave floating, because a break cost on money you were about to repay anyway is the most avoidable cost on this page.
Between the two sit the hedges. An interest rate swap turns a floating loan into a fixed one without changing the loan; a cap sets a ceiling and leaves the rate free below it. Both are arranged through the bank's markets desk, both carry their own credit approval, and both let a business fix its core debt while its facilities stay flexible. Which is right for a given business is a conversation to have with the numbers in front of you, not a product to accept from a call.
// 06 — THE MISTAKES, IN BOTH DIRECTIONS
Fixing out of fear. Rates have risen, the bill hurts, and the whole loan is fixed at the new level for five years — and then repaid two years later on a sale, with a break cost. Floating because it is cheaper today. The floating rate is below the fixed, so the business takes it, on a loan whose cover cannot stand a rise; the saving is real until the first reset. Fixing what will not be there. A loan the business intends to refinance at the next review fixed for longer than the review cycle. Forgetting the refix date. The fixed period ends, the loan rolls to floating at whatever the rate is, and the first the business knows is the statement. Treating the bank's rate view as advice. The bank does not know where rates are going either; what it knows is your cover, and that is the question to ask it.
// 07 — SO WHICH ONE
Run your own cover at today's rate, then with a larger interest bill, and look at the gap. If a rise would take cover below what the covenant needs, the risk belongs with the bank: fix or hedge the core debt for as long as it will be there. If the business can carry a rise and may repay early, the risk belongs with you: float, and keep the freedom. Most businesses land in between and do both, on the rule in section 05. And whichever you choose, ask for the break-cost clause before you sign and put the refix date in the diary — the two things that separate a decision from a surprise.
// QUESTIONS BORROWERS ASK
- Is a fixed or floating rate better for a business loan?
- Neither is better; they allocate one risk differently. A floating rate moves with the market both ways and leaves the business carrying the chance of a rise; a fixed rate hands that chance to the bank for a period, at a price, and takes away the flexibility to repay cheaply. The right choice depends on what the business can absorb, not on a view of where rates are going: if a rise in the interest bill would take cash cover below what the loan needs, the risk belongs with the bank; if the business could carry a rise and may repay early, it belongs with the business.
- Can you fix the rate on a business overdraft or a line of credit?
- Not usually, and for a reason. An overdraft is repayable on demand and priced daily on whatever is overdrawn; a revolving line is drawn and repaid at will. Neither has a balance the bank can fund or hedge for a fixed term, so both float. Fixing belongs to term debt — a loan with a known balance and a known schedule — which is where the bank can arrange its own funding at a fixed rate and pass the certainty on. A business that wants rate certainty on a working capital line usually gets it through a hedge on the core balance rather than by fixing the line.
- What is a break cost on a fixed-rate business loan?
- The charge for repaying fixed-rate money before its fixed period ends. When the rate was fixed, the bank funded or hedged the loan at that rate for the whole term; if market rates have fallen since, unwinding that position costs it money, and the break cost passes the loss to the borrower. It is not a penalty and it is not constant — it can be nothing when rates have risen and large when they have fallen — which is why the facility agreement's break-cost clause is read before a rate is fixed, not when the business wants to leave.
- Can a business fix part of a loan and leave the rest floating?
- Yes, and it is the usual answer rather than the exception. A term loan can be split into a fixed tranche and a floating one, or fixed for a shorter period than the loan, or hedged in part with an interest rate swap or a cap arranged through the bank's markets desk. The rule most desks apply is to fix the part of the debt that will certainly still be there for the whole fixed period, and leave floating the part the business may repay, refinance or reduce — because the floating part costs nothing to repay and the fixed part may.
- Does the bank prefer a fixed or a floating rate?
- The bank is largely indifferent to which you choose, because it hedges either way; what it cares about is whether your cash flow survives a rise. A credit desk reads interest cover at today's rate and again at a higher one, and where cover is thin it may make some fixing or hedging a condition of the approval. The bank's own interest rate risk is managed in its treasury, not in your loan — so the conversation to have is not which rate the bank wants, but how much of a rise your business can carry.
// RUN YOUR COVER AT A HIGHER RATE
The Three Diagnostics take your numbers and show what a desk would see. Run them once as they are, then once with a larger interest bill, and the gap is your answer. Free, nothing stored.
Open the diagnostics →