Question

What motivation encourages commercial banks to make variable-rate mortgages? Why are variable –rate mortgage rates normally below fixed mortgage rates? In an increasing rate environment, would you expect banks to increase or decrease the adjustable-rate proportion of their mortgage portfolios?

Answer 1

The term of mortgages loans usually is spread for over very long periods. It will difficult for the lender to estimate the interest rate conditions that will prevail during the entire duration for such a long period. Hence, a variable rate mortgage is offered by banks. Interest rates of variable rate mortgages are lower than fixed rate since , the variable rate is fluctuating and calculated using a fixed base rate plus a fluctuating rate. Hence, the lender makes more money over time with increasing inflation than a fixed rate that remains same over the tenure of the loan. Hence the rate is lower. The banks are likely to increae their adjustable rate proportion of their mortgage portfolio in case of increasing interest rates.