Construction Law Today : Construction Lawyer & Attorney : Joshua Glazov : Design Build Contracts, Construction Bankruptcy

Introduction To Floating Interest Rates

In the last post we talked about pros and cons of fixed interest rates. When a fixed interest rate doesn't fit the bill, the alternative is a floating rate. As promised, today we'll talk about floating interest rates, some problems with them, and some suggestions for making them work better in your contracts.

Keeping in mind from the last post on fixed interest rates, the longer the amount of time between setting the rate and when interest actually gets charged, the greater the chances that interest rates at large will change.

Problems With Bank Rates and Publication Rates

Contracts usually set floating interest rates by reference to some widely available rate or index and then add percentage points to it. If you want to sound work on Wall Street, you can add basis points instead. I frequently see something like "the Prime Rate, plus 4%." This works OK, until you ask questions like:

• Which Prime Rate? The Wall Street Journal's Prime Rate? Bank of America's Prime Rate? Chase's Prime Rate?
• What happens if the Prime Rate source is no longer available?

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Interest Rates You'll Usually Find

Under most architects agreements and construction contracts, interest gets added onto late payments. I can't remember the last time I saw one of these contracts that didn't add interest to late payments and identify the rate of that interest. But almost as often I notice problems with how the rates are set. The two most frequent problems:

• Fixed interest rates. They could turn out to be too high. Or too low.
• Floating interest rates where the floating rate index is difficult, or impossible, to identify.

Whether fixed or floating, the interest rate you find in architects agreements and construction contracts is usually simple interest, not the more complex, and suspect, compound interest. In most cases it's better to stick with simple interest.

Fixed Interest Rates - The Virtue of Simplicity

Today we'll focus on fixed interest rates. In the next post we'll focus on floating rates.

Fixed rates offer a simple solution. It's easy to identify, never changes, and it's easy to calculate how much interest to add. Simple is usually good. But Albert Einstein said "everything should be made as simple as possible, but not one bit simpler." Sometimes the simplicity of a fixed interest rate is just too simple. When?

• When the amounts of money are large - $250,000 and up.
• When there is a long time between when (1) you set the interest rate and (2) interest starts getting added to a late payment.

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