Floored loans expose borrowers to risks.

If the floating rate falls below the floor rate, the borrower pays more than the floating rate.

The risks of a floored loan are increased if early exit charges apply.

In that case if interest rates fall, the borrower risks becoming trapped in an expensive arrangement which may be difficult to exit without incurring break costs. If the break costs are linked to the value of the adverse floor, they could potentially be substantial as a percentage of the amount borrowed.

The adverse floor element may also impact the borrower’s loan-to-value position.  The contingent liability created by the potential break cost of the floored loan effectively adds to the amount being borrowed.

In some circumstances the contingent liability can lead to breaches of loan-to-value covenants and place the borrower in default of their loan obligations.