Sharing the Interest Rate Risk

When it comes to discussions of adjustable rate mortgages, there is a lot of confusion. Most people understand that the interest rate can be reset at intervals set in the loan agreement. In exchange, they further understand that they typically get a lower interest rate and payment than they would with a fixed rate loan. At least up front. What few people understand is why adjustable mortgages work this way or even exist. The answer is simple – to share the risk. A lender making a fixed rate loan is betting that future interest rates will not rise above the rate on the loan. This is risky as rates move. With adjustable rate mortgages, the lender can reset the loan and is thus burdened with less risk. As a result, it is willing to give you an initial interest rate much closer to the lower rate it costs the lender to borrow the money.

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