If I borrow 200k from a bank or building society to buy a house in say 2018, why is the interest rate on that loan variable for the next 25 years? Shouldn’t it be the internet rate when the bank loans the money to me.
If the bank has loaned me money when interest rates are low, then interest rates go up, aren’t they just creaming off a whole load of profit from me?
In: 10
Rates vary with the market. Rates are how they make money off of you. They want the highest rate possible while not losing business because people can get better rates elsewhere.
In an adjustable rate mortgage, you may start out with a lower rate. This means they are making less money on you. The rate adjusts with the market. So while you may start out with a lower rate, it can (and usually does) increase.
In a fixed rate mortgage, you agree on a set rate and that’s it. For that particular mortgage, your rate is set and will not change. It’s much more stable for both parties. Because of that, your rate will likely be higher than the starting rate of an adjustable rate mortgage.
Say an adjustable rate mortgage starts at 1.5% and is capped at a possible 1% rate increase per year up to say 7%. Year 1 you’re paying 1.5%, year 2 2.5%, year 3 3.5%, and so on.
If you could get a fixed rate mortgage at 1.5%, you would never consider an adjustable rate and the mortgage company wouldn’t make nearly as much money off you. Instead you may have a 4% fixed rate. So you’re paying more in interest the first few years but you’re protected if rates go up in the future.
TLDR: Adjustable rate mortgages are basically a discount in the first several years of your mortgage in order to secure business for the mortgage company with a good likelihood of making the money back up on the later part of the loan.
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