Term Of The Day: Adjustable Rate Mortgage
In an adjustable rate mortgage, the interest rates vary according to the cost of borrowing for the bank or financial institution that lends to you, or some other specific benchmark.
PropTiger Explains Adjustable Rate Mortgage
In adjustable rate mortgages, equated monthly installments rise or fall when interest rates rise or fall. Typically, banks and financial institutions charge an interest rate lower than that of fixed interest loans for adjustable rate mortgages. Adjustable rate mortgages are also known as floating rate mortgages. They are known are adjustable rate mortgages or floating rate mortgages because the interest rates float or adjust over a period of time, according to the fluctuations in credit market conditions and changes in monetary policy.
In India, when interest rates rise or fall, lenders generally do not raise or lower the interest rates. Instead, they extend or shorten the loan tenure period. But, if the loan tenure period if 20-25 years, when the interest rates rise, banks raise the EMI instead of extending the tenure period. In India, the monetary policy of the Reserve Bank Of India (RBI) plays a crucial role in influencing the interest rate of floating rate mortgage loans. You can switch from a fixed interest rate loan to a floating interest rate loan too. But, you will have to pay processing charges and other fee. Even after adjusting for switching costs, if it is still worth it, it makes sense to switch.
Even though fixed-interest rate mortgages are considered more stable, homebuyers often end up paying more, especially in countries like the United States, because the interest rates are higher and fixed. Moreover, in some banks, fixed interest rates would be fixed only till a certain period in the loan tenure period. But, still fixed interest rate mortgage loans would be cheaper if interest rate are only likely to rise during the loan tenure period.
If the interest rates are unusually high, and only likely to fall, taking an adjustable rate mortgage loan makes more sense, especially if the amortization period is long. In the loan tenure period, the interest rates in an adjustable rate mortgage loan are rarely likely to fall above the interest rates in floating rate loans. Home buyers find that it is more difficult to budget with an floating rate mortgage loan. Still, most home buyers in India prefer it because it is often not worth paying a much higher EMI for stability of the payment schedule.
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