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Adjustable Rate

An adjustable rate [1] is a rate usually set a few percentage points above the prime rate that is offered to home buyers when the prime rate is higher than normal. A buyer opts for this arrangement in hopes that the prime will go down, thus bringing the interest rate [2] down also. If a buyer were to lock into a fixed rate when the prime rate is high they would lose out when rates drop, while the person without a fixed rate would have their rates lowered.

No one would opt for an adjustable rate when the prime is at historic lows. Instead, a buyer would lock into a fixed interest rate so that if the prime rate increases, mortgage [3] payments and interest would remain the same.

The rate of inflation [4] determines where the prime rate will move. If the prime rate goes up, the individual without a fixed rate may find they are unable to make their mortgage payments. The bulk of home foreclosures are a direct result of an individual’s inability to contend with rising interest rates [2]. The rise of foreclosures affects the whole economy and can pull it into a recession [5]. Most governments attempt to control the prime interest rate in order to avoid inflation and a downswing in the housing market.

Historically, housing is a safe investment option, but when the economy tanks and interest rates tumble, all investors feel the crunch. Then there usually is a scramble to refinance at fixed rates, especially if rates are at historic lows.