RealTown Words

An approach to financing in which the lender is permitted to alter the interest rate under a loan, with a certain period of advance notice, based on an agreed basic index, such as the prime rate. Monthly mortgage payments can then be increased or decreased, or the maturity extended, depending on how the base index varies. For example: “The sum of $50,000 payable in monthly installments of $400 each, including interest on the unpaid balance at the rate of 7 percent per year or 2 percent higher than the prime interest rate in effect at the Bank of Primo, whichever is greater (such rate to be established once each year on the first banking day of each calendar year), provided that the interest rate shall not exceed the maximum rate permitted by law.”

A variation of this concept is the one-year maturity/20-year amortization mortgage loan. At the end of the year, the loan is renegotiated at the then-current interest rate, and the remaining principal balance and new interest payments are spread over a 19-year period. This process continues every year the loan is outstanding.