Adjustable Rate

by Investing School on August 20, 2009

An adjustable rate 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 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 payments and interest would remain the same.

The rate of inflation 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. The rise of foreclosures affects the whole economy and can pull it into a recession. 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.

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