Accounting Dictionary

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Interest Rate Swap

Definition: An interest rate swap is an agreement between two parties to exchange interest payments in the same currency over a defined time period, which normally ranges from one to ten years. One of the parties is paying a fixed rate of interest, while the other is paying a variable rate.

By engaging in a swap, a company can shift from fixed to variable payments, or vice versa. By shifting to fixed interest payments, a company can better forecast its financing costs and avoids increased payments, but loses the chance of reduced interest payments if rates were to decline.

An interest rate swap is especially useful for a company with a weak credit rating, since it must pay a premium to obtain fixed-rate debt; it can instead procure a variable-rate loan and then use an interest rate swap to secure a fixed-rate payment schedule.