The adjustable rate loan is also called variable rate loan. The monthly installment of the borrower may vary over time depending on the benchmark on which the financing is based. This type of loan is not much demanded by borrowers in France because it has an unknown random nature that can scare them, but most European countries only practice adjustable rate loans. Many adjustable rate loans have been developed to protect borrowers from rate hikes and make them attractive.
Why choose a variable rate loan?
The main motivation for choosing a variable rate loan is based on the rate spread versus a fixed rate loan. It is also subscribed because many contracts provide security for the borrower in the case of evolutions indices.
What is the benchmark for setting the rate of the revisable loan?
The benchmarks most often used by credit institutions to establish their adjustable rate schedules are the 1-month, 3-month or 1-year (USD zone interbank rates). The financial institution will apply an additional margin corresponding to its remuneration and the risk criterion.
Secured adjustable rate loans
Subscribing a variable rate loan does not necessarily mean going to the unknown in the event of an increase in the indices. Many contracts have limits to secure the borrower. These are the rate-adjustable loans “CAPE”, the cap (English cap) of limiting upward or downward changes in rates.
Caps are often expressed as a percentage, for example Loans revisable Cape 1 see a limit of change in the rate of departure of the loan to 1%, Cape 2 to 2%. Some offers even provide for the possibility of readjusting the starting rate in the event of a fall in the indexes, which allows the borrowers to save money. But if the prevailing rates are at their lowest, the borrower is likely to see his monthly payment only increase.
In the event of an increase in the rate, the lender will recalculate the monthly payment, if the recalculation exceeds the repayment capacity of the borrower, the duration of the loan may be extended if the loan offer so provides.
In the event of a decrease, the lending organization will carry out the same calculations on the contrary, it will first choose to reduce the duration of the revisable loan.
Advantages of the adjustable rate loan and disadvantages
- Borrowing period equals fixed rates are more expensive than revisable rates
- Security: certain contracts secure the borrower in case of evolution of the indices
- Period of product fixity: the lending institution may agree a period at the beginning of the loan during which it undertakes not to change the rate of the mortgage
- Ability to switch to fixed rate and product flexibility
The inconvenients :
- Evolution of the indices based on the European monetary policy gives an unknown character of future repayments
- If the prevailing rates are at their lowest, the possibilities of decline are very limited
Useful information :
The adjustable rate loan may receive one or more of the following financial characteristics:
- deferred total or partial depreciation
- loan smoothing or repayment levels
- postponement of deadlines