When signing a contract with the bank it is good practice to read and understand the meaning of all the clauses that can be found in the text to be signed. In particular, if we are signing a loan agreement, this arrangement should not be overlooked, even if, as we shall see, the legislation imposes a certain degree of transparency on certain clauses that may be pejorative for the consumer.
When we talk about variable or mixed rate mortgages we can come across some concepts that are good to have clear: let’s talk about the cap, floor and collar clauses
First of all, this type of clauses may be present in the event that the interest charged for our mortgage can change over time – we are therefore talking about variable or mixed rate mortgages.
If we take the simplest case, a variable rate mortgage, as we generally know we will have an interest given by the sum of two components: a variable (generally the reference index is the Euribor ) and a fixed one, the spread applied by the bank. The rate applied, and consequently the amount of the installment, may therefore vary over time.
In the first instance, the conclusion could be simply that the cap clause is to the advantage of the consumer, the bank’s floor clause : an upper limit to the interest rate is in fact a caution for the customer that could limit the damage in the event of a significant increase in rates on the other hand, a lower limit does not allow the consumer to fully enjoy the advantages of a net decrease in the rates themselves.
But it is opportune to deepen the topic and also make other considerations
As we said the ” cap ” is a clause that provides an upper limit to the value of the interest applied. Let’s assume we have a variable rate mortgage given by the sum of a 1% spread + 3 month Euribor and initially the value of the latter is 0.5%. We will then, at an early stage, an interest rate of:
We also assume that we have a clause that provides for a 3.0% cap: if the 3-month Euribor is increased, the interest applied by the bank will also increase, up to a value of 3% (corresponding to a 3-month Euribor value) of 2.0%). If the 3-month Euribor continues to rise, the rate applied by the bank would in any case remain anchored to the threshold value of 3%.
However, this mechanism is generally paid. In fact, the “variable with cap ” has become over time a type of mortgage sold by banks as a solution for those who want to combine the advantages of a variable rate mortgage with the security of the “cap”. But beware: generally the spread applied by the bank is higher than that of a variable rate mortgage without cap: security has a cost….
Also read: Variable rate mortgages with cap
If the cap is “flaunted” by the bank, which, as we have seen, wants to offer a particular type of loan to its customers in general against a higher spread, the floor clause could instead be less evident and therefore undervalued by the consumer.
Moreover, the more cautious are concerned about having solutions in the event of an increase in rates, but sometimes they forget that the advantage of a variable rate mortgage is also that of being able to enjoy eventual reductions in interest rates (and Euribor in particular).
The floor clause has a mechanism similar to the cap but, as we have seen, it sets a limit to the downside of the interest rate. An interesting situation is that which occurred in 2015, when the Euribor fell for the first time in negative territory, and many wondered: what will happen to my mortgage? Will the interest rate applied by the bank enjoy this benefit, and will therefore be even lower than the spread?
The answer in this case is not unique: In the absence of floor unaclausola the interest rate may fall below the level of the spread applied by the bank, fully exploiting the value of the ‘Euribor turned negative. In other cases, on the other hand, a specific clause put by the bank puts a brake on the reduction in interest applied. For example, a typical formula that we can find in contracts is that which explicitly informs the customer that the rate applied can never be lower than the spread.
Many have wondered in the past whether such a clause was legitimate, as it was clearly favorable to the banks. To date we can say that this type of clause is legitimate if it is expressed in a clear and transparent way both in the information of the pre-contractual phase and in the loan agreement, and must obviously be signed by the client, under penalty of invalidity of the clause itself