Fixed vs Floating Charge
Fixed and floating charges are mechanisms used to provide a lender with security over a borrower’s assets. The main difference between the two lies in the types of assets held as collateral and the flexibility in disposing the asset over the life of the loan. The type of charge chosen will also affect the lender’s risk of loss, and the borrower’s flexibility in carrying out business operations. The article offers a clear overview of each term and explains how they are similar and different to each other.
What is Fixed Charge?
A fixed charge refers to a loan or mortgage of some kind that uses a fixed asset as collateral to secure loan repayment. Fixed assets that can be used as collateral in a fixed charge include land, machinery, buildings, shares and intellectual property (patents, trademarks, copyrights, etc.). In the event that the borrower defaults on his loan, the bank can sell the fixed asset and recover their losses. Due to this requirement, when a fixed charge is made over a fixed asset, the borrower/debtor cannot dispose the asset and the asset must be held by the borrower until the total loan repayment is made. There are instances in which the asset is disposed; however, the borrower will have to obtain consent from the lender to do so.
A fixed charge is beneficial to the lender as it gives a higher level of security and lower risk of loss. On the other hand, however, a fixed charge can reduce the flexibility available to the borrower.
What is Floating Charge?
A floating charge refers to a loan or mortgage on an asset that has a value that changes periodically to secure loan repayment. In this case assets that do not have a constant value, or are not fixed assets such as stock inventory can be used. In a floating charge, the borrower has the freedom to dispose the asset (for example, sell stock) in the course of normal business activities. In the event that the borrower defaults on their loan, the floating charge freezes and becomes a fixed charge, and the inventory left over from the time of default cannot be disposed and will be used as a fixed charge to recover the outstanding debt.
A floating charge is favourable to the debtor as it provides greater flexibility and does not tie up funds or operations since trade can continue as usual until a default occurs. The other advantage of using a floating charge is that even smaller firms that do not have large fixed assets can borrow funds. However, a floating charge may not be beneficial to the bank as there is a larger risk involved in that the value of the asset left over may not be sufficient to recover the total loan amount.
Fixed vs Floating Charge
Fixed and floating charges are similar to each other as they are both mechanisms used to provide the lender with security over the borrower’s assets. The main difference between a fixed and floating charge is that the ability and flexibility it provides the debtor/borrower in disposing assets. A fixed charge is beneficial to the lender as it offers the lender greater security over the loan, but can be problematic to a borrower who has to maintain the asset until the debt is repaid.
A floating charge is beneficial to the borrower since the asset can be used in the normal course of business until a default occurs. However a floating charge is risky to the lender, who may not be able to recover total losses.
Summary:
Difference Between Fixed and Floating Charge
• Fixed and floating charges are mechanisms used to provide a lender with security over a borrower’s assets.
• A fixed charge refers to a loan or mortgage of some kind that uses a fixed asset as collateral to secure loan repayment.
• A floating charge refers to a loan or mortgage on an asset that has a value that changes periodically to secure loan repayment.