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Category: Articles » Finance » Mortgages » Article » Article Code

Adjustable Rate Mortgages

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An adjustable rate mortgage, variable rate mortgage or floating rate mortgage is a mortgage loan where the interest rate on the note is adjusted from time to time based on an index. This is done to ensure a steady margin of interest for the lender, whose own cost of funding will usually be related to the index. As a result, payments made by the borrower may change over time with the changing interest rate (alternatively, the term of the loan may change).This is not to be confused with the graduated scale of payment mortage, which offers changing payment amounts but an interest rate which remains constant. Other forms of mortgage loan include interest only mortgage, fixed rate mortgage, negative amortization mortgage, discounted rate mortgage and balloon payment mortgage. Adjustable rates transfer part of the interest rate risk from the lender to the borrower. They can be used where fluctuating interest rates make fixed rate loans difficult to obtain. The borrower profits if the interest rate decreases and loses out if interest rates increase.

Adjustable rate mortgages are characterized by their index and limitations on charges (caps). In many countries, adjustable rate mortgages are the norm, and in such places, may simply be referred to as mortgages.

In many countries, banks or similar financial institutions are the primary facilitators of mortgages. For banks that are funded from client deposits, the client deposits will typically have much shorter terms than housing mortgages. If a bank were to offer large volumes of mortgages at fixed rates but to derive most of its funding from deposits (or other short-term sources of funds), the bank would have an asset-liability which would be lopsided: in this case, it would be running the risk that the interest income from its mortgage scheme/s would be less than it needed to pay its depositors. Some argue that the savings and loan crisis was caused by this mismatch and that the savings and loans companies had short-term deposits and long-term, fixed rate mortgages, and were caught when interest rates were raised.

To avoid this risk, many mortgage facilitators sell or securitize their mortgages. Banking regulators closely monitor asset-liability mismatches to avoid such problems, and place tight restrictions on the amount of long-term fixed-rate mortgages that banks may hold (in relation to their other assets).

In this perspective, banks and other financial institutions also offer home equity loans, credit cards and mortgage calculators apart from adjustable rate mortgages because it reduces risk and matches their sources of lending.

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