Adjustable rate loan

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An adjustable rate loan is a loan where the interest rate changes over the life of the loan.

Home loans

Usually the interest rate will start low and then increase based upon the terms of the contract. It is common to have a loan cap and incremental caps over specific time periods. Rates usually start much lower than for fixed rate loans and are therefore easy to qualify for. The loans will usually be tied to a specific index such as the prime or the LIBOR. Adjustable rate loans are usually more popular for people having difficulty qualifying or for those who don't expect to stay in the house for long.

Ex. A loan may start with 2.9% rate tied to the prime rate + 2%. The loan will readjust every 6 months with a maximum increase of 2 percent per adjustment. The loan cap is 15.9%

Home loan interest rates can be linked to the general interest rate. When interest rates rise people may suddely find that they can't afford their mortgage repayments of have to cut back other expenses and reduce their living standard drastically. When large numbers of people cut back in this way this can reduce demand in an economy and trigger a slump or aggravate an existing slump.

see Financial Crisis of 2008