Why would a Savings Institution prefer to lend borrower at fixed-rate instead of adjustable-rate?

Question

Savings Institution bears less interest rate risk if they lend money at fixed-rate, but some institutions prefers adjustable-rate, why?

What if the market has upward-sloping yield curve? What are the reasons that Savings Institutions want to lend money at fixed-rate?

Answer 1

Assuming you're talking about mortgages, the banks don't hold the actual debt anyway. They sell the loan to Fannie Mae or Freddie Mac or other outlet. Fannie then creates bonds, which are sold to bond investors on Wall Street.

So it's the bondholders that ultimately absorb the interest rate risks.

A typical scenario: You get a mortgage for 6.00% from Bank X. You continue making your payments to Bank X. However, Bank X is only receiving a servicing fee, usually about .25% per year. The underlying debt has been sold to Fannie Mae.

So, Fannie Mae is getting 5.75% of that money, after paying the servicing fee to Bank X. Fannie Mae will keep some amount, let's call it .75%. Which may be close to reality, because often Fannie will guarantee certain paybacks on their bonds. They create a bond, with a pool of their loans, that pays 5.00%.

Grandma Gertrude wants a safe place to invest her money. She goes out and buys the bond. She's the one at risk of having the investment devalued by inflation and interest rate climbs, and early payoffs and defaults. Which is why bonds are so often sold in mutual fund pools, so you're only buying a fractional piece of any single debt. And the circle of money is now complete, in that the bank has all that money to lend again, and still earns a residual income from the original loan they created.

I think you'll find that, at least historically, banks can't hold long-term fixed paper in their own portfolios, at least they're limited in that ability. Time was that small banks could only offer 5 year ARMs or balloons if they wanted to hold the note in entirety. It's possible some regulations have been loosened on that, but I think mostly it's still the case.

A bank that prefers adjustable rates is likely holding those loans directly in their portfolios, or is attempting to increase their holdings, but to do so, they need to remove their own rate risk and put that risk on the borrower instead.

Answer 2

Banks like to have a mix because even they cannot predict what will happen with interest rates. Fixed rates can be good if rates fall--or bad if rates rise. Since many loans last for years and years, sometimes the bank may be in a favorable position and sometimes they aren't. They make sure it balances out by raising or lowering the rate they're willing to fix at. Or by making more or fewer fixed rate loans.

Answer 3

Your explanation seems different than your question. In any case, though, institutions often prefer an adjustable rate mortgages because they can raise rates dramatically later. But often, lately, they are raising rates and borrowers are finding themselves in over their heads, so they let it go to foreclosure. This is bad news for the institutions, and many are offering fixed rates so borrowers know what to expect and thus there are fewer foreclosures.

Answer 4

Financial institutions, make money by borrowing money. If the Prime is 4% and I loan to you at 8%, all is well and I make money without spending any of my own. If Prime go to 6%, I have to cut my cost of operation by 50% or I will loose my shirt. This will not happen if your loan is adjustable, I just pass the added cost to you.

Answer 5

Long term people who have adjustable rate loans go into default and get foreclosed on more than a standard 30-year or 15 year loan. They usually wind up losing money in the long run on them.

Answer 6

In some cases, fixed rates are offered if they are considered short term. 5 years or less.

Almost all commercial loans are done on an adjustable basis. This allows fluctuations in Treasuries and will reprice the loan accordingly.

If you are refrring to personal loans, most of the time they are to small to worry about adjusting them.

Answer 7

When rates are headed down, then places like to lend at a fixed rate. If rates are headed up, they'd prefer to lend at adjustable rate. That maximizes their profits.

Answer 8

I paintings for a large very own loan lender-- constantly do a fastened fee. I truthfully have considered costs for a 2nd as low as 7.00% hands (Adjustable fee Mortgages) can leap as severe as 10, 11, 12%......

Answer 9

They do fixed rate when their research suggests that the average rate over your term will be lower that the one they offer.

Answer 10

if you have a fixed you are less likly to refi if you have an adjustable you most definatly refi at the adjustment due date