Double advantage with interest rate cap: benefit from low interest rates and prepare for the future

30.7.2010As the Euribor rates are still at low levels, this is an excellent time to make sure that interest expenses will remain low also in the future. An interest rate cap enables you to ensure that interest expenses will not rise drastically from current levels while allowing you to benefit from current exceptionally low rates.

As the Euro-zone economy has recovered, the European Central Bank has slowly been dismantling its exceptional stimulus measures, which has also affected Euribor rates. The rates have been slowly increasing and are already clearly past their lows. Several ECB Governing Council members have expressed that in their opinion interest rates were kept too low for too long during the years 2003 - 2005 and that the same mistake should not be repeated now. Although economic recovery and the future ECB policy is still uncertain, on the longer term Euribor rates will most likely climb up from their current low levels.

Favorable time to enter into an interest rate cap

The timing is thus appealing to benefit from current low interest rates and simultaneously achieve protection against a potential future rise in reference rates by purchasing an interest rate cap. Interest rate caps are now obtainable at very reasonable prices, as the market does not yet price a rapid rise in interest rates. If the Euribor rates continue on their upward trend, the prices could quickly rise, however. With an interest rate cap, it is possible to enjoy low interest rates without having to worry about reference rate increases leading to loan servicing costs exceeding your payment capacity due to market movements.

In practice, the costs of the interest rate cap are paid in advance, and thus they can be added to the drawdown amount. A loan margin is always added to the reference rate payable.

Benefits of the interest rate cap:

• The current market situation enables the purchase of an interest rate cap at more attractive prices than before.
• The interest rate cap hedges against reference rate rises.
• Should interest rates fall, the full benefit is still obtained for rates below the interest rate cap level.