variable rate loan products and how the rate works

Everything else
1

I’ve gotten a variable rate loan HELOC before but I do it so infrequently and the products change from time to time. I have one I’m closing on now, but I still don’t understand how the rate is calculated. I have to ask the loan officer tomorrow, but I thought I would bring it up here.

So this is how the rate is calculated for the current loan:

Prime (4.25) x the margin (-0.260) = APR (3.990)

Okay, so it’s variable. In the past, that meant that when prime changes, they recalculate. But this time, they’re saying that not only can prime change, but the margin can also change.

I was like huh?

With prior loans, it’s always just been prime that is the, uh, variable in the variable rate. Also, I’ve never had a variable rate that had a negative value before. Usually it’s been like 1 point over prime or something. If prime was 4.25, and the rate was 1 point, then the APR was 5.25. If prime went up, then the APR went up too, by the same amount (1 point).

With this one, it’s got this margin thing, which it says is “based on my Loan-to-Value”. Okay, that makes sense. The bank had different margins based on different LTV. There were like 3 or 4 rates and we strategically picked our loan amount to get the lowest rate.

It says in the small print that the both the index and the margin can change. I think that means that if the market changes, and the house is suddenly, say, worth less than it was at calculation time, than the margin can change. At least, I think that’s what it means. I couldn’t get a straight answer from the clerk I worked with tonight. He was just a low level guy, so he probably just didn’t know. But I didn’t even realize the margin could change until I read the thing tonight. I don’t see a list of the rates and their associated LTVs in the signing papers though, so maybe I’m just totally off base here. The way the kid explained it the margin was just determined by the “board” or some such other black box arrangement that doesn’t involve, like, numbers or fancy equations with symbols and stuff.

So I don’t know.

I really need the HELOC right now and I don’t want a fixed rate product, so I’m probably going to not going send it back, but Jesus. What a pain. There was another clerk with braces at the bank tonight and she kept repeating “Sir. Sir, we can’t know what prime will be.”

In my head I was like, Fuck!

I was cool though.

I just sighed and said, “Yeah. Yeah. We can’t know that.”

2

It’s impossible to say for sure without seeing the mortgage terms themselves. And absolutely do not sign until you are sure you understand them, and under what constraints, if any, the rate can change. These should be specified either in your specific mortgage docs or in the lender’s general conditions, or both. READ THEM ALL.

But, speaking from general knowledge of the UK market, where unlike the US variable rates are the norm, you can broadly speaking either have a rate with a basis set by reference to some external rate (ie Prime here) and a predetermined margin (eg -0.26%), or you can have a rate which is basically set at the lender’s discretion (usually known as a Standard Variable Rate), which sounds kind of like what you may have. Obviously there are variations on the theme with teaser rates or fixed rate periods, but that’s the general pattern.

In practice, most of the time, the SVR will fairly closely follow the tracker rate, for competitive reasons. But in times of stress, when they’re not competing for business but just trying to squeeze money out of existing customers, the SVR will go way higher. Always go for a tracker if you can. Don’t trust your lender if they have meaningful discretion to change the rate. I’d be surprised if your margin was supposed to change dynamically based on LTV, not least because that would in principle involve getting a new valuation, and lenders don’t typically like doing that until a loan has defaulted. Much more likely the initial margin is a function of the LTV, but they reserve the right to vary the margin in future. Like I say, I would never accept a mortgage that does this. They may be cheaper initially, but they bite you in the ass when you can least afford it, and are least able to refinance away.

3

Yeah, it doesn’t pass the sniff test for me. Prime rate + fixed% is easy to understand and can bite you in the ass enough if things go to crap, but Prime rate + ? is asking for trouble.

4

Okay, thanks for the input guys. I talked to the actual loan officer and she clarified some stuff for me. Turns out the margin doesn’t change, only the index (prime) can change.

Those young clerks must have given me the heebie jeebies. I was reading stuff into the small print that wasn’t really there.

So, this for the win:

Haha, after the loan officer assured me it worked the same as previous loans, I read the same stuff again and realized it didn’t say what I thought I’d read last night. Whew!

Big sigh.

:)