Adjustable rate loans have an initial interest rate set for a fixed term, thereafter, the rate on the loan resets based on a stated term at a spread over/(under) some market index.
That index could be based on the prime rate, certain maturities of US or foreign government treasuries, Libor/swap curve, brokered CDs, cost of funds, or a bank or financial institution’s self-defined index.
The purpose of adjustable rate loans is to provide a degree of interest rate protection to the bank or credit union while allowing it to offer a longer maturity loan to a borrower. PrecisionLender allows for this rate type:
When the rate type selected is adjustable, additional entries must be made above those required for a fixed rate loan. These are:
- The index that will be used at the time of adjustment
- There are up to five families of indices that can be selected. The custom index is usually only shown if the institution uses an internal index that is put into PrecisionLender. The institution’s model administrator can also choose to eliminate other families of indices. PrecisionLender will default to the family set by the institution.
- The maturity of the index that will be used
- Once the family is chosen, PrecisionLender will show the index with the maturity closest to the given period in the adjustment frequency. In the case below, the adjustment frequency was set at 12, so the index is assumed to be 12-month treasury. The current rate is also shown. If another maturity period is actually used (i.e. a 3-year treasury), the user can switch to that index.
- The spread to the index at time of adjustment
- This is usually some positive amount, although when prime is the index, it may occasionally be negative. PrecisionLender will recommend a spread that will meet the target ROE requirement. A cap and/or floor can also be chosen. For more information on using caps and floors, please click here.
- The fixed period
- The fixed period is the time frame that the initial rate is in effect. If the initial period is 60 months and the interest rate resets for every 12 months thereafter, enter 60. The time period shown is always in months. If the initial period is one year, 12 should be entered.
- The adjustment frequency
- Adjustment frequency is the time period, in months, when the reset rate is effective. For more details on adjustment frequency, please click here.