3DCM launches interest rate cap
Share
3D Currency Management has launched a interest rate cap, which gives borrowers some protection if the Bank of England base rate rises too quickly.
An interest rate cap is basically an insurance against rises in the interest rates. Caps can be arranged to protect against rises in the Base/LIBOR rate over three, three and a half or 4% for a term of three-fiveyears.
The cap is purchased using a one off up front premium. Once in place the cap will pay out if the Base/LIBOR rate exceeds the chosen level.
The price of this protection depends on the predicted level of interest rates over the five-year period. As such the cost of this protection is low when the expectation is that rates will be low for a period of time.
If for example a client has a £1m loan and their mortgage tracks the Base Rate with a 1% margin and five years remaining.
The rate applicable to the loan is Base Rate plus a margin of 1% for a ten year term with five years remaining.
With the Base Rate at 0.5% this client is currently paying 1.5% per annum for the £1m loan.
The client is concerned that Base Rates could move up quickly in the next five years and therefore buys an interest rate cap at 3%. The cap is purchased with a one off premium and is owned by the client. This is held as an asset that can be sold at any time. The value of this asset will fluctuate and could be worth less than they paid for it.
During the five year term of the product the interest rate cap will pay out at any time that the Base Rate is above 3%, therefore effectively capping the rate at this level.
The customer will continue to pay the mortgage at the original rate of Base Rate plus 1% lending margin but will receive from the cap a payment equal to the difference between 3% and the prevailing level of the Base Rate.
Whenever the cap is being used the payments are arranged for the same day as the mortgage payment is taken in order to net off for cash flow purposes.
If the Base Rate does not rise above 3% over the 5 year term then the premium will have been paid but the cap will have not been used at any point.
This product will also appeal to many borrowers who have finished their fixed rates and who are now on their lenders standard variable rates.
