What is the key difference between a fixed-rate and variable-rate mortgage in terms of interest rate risk?
Correct Answer
C) Variable-rate mortgages transfer interest rate risk to the borrower
Variable-rate mortgages transfer interest rate risk from the lender to the borrower, as payments can fluctuate with changes in the prime rate. Fixed-rate mortgages protect borrowers from rate increases during the term but may result in higher costs if rates decline.
Why This Is the Correct Answer
Option C correctly identifies that variable-rate mortgages transfer interest rate risk from the lender to the borrower. When interest rates rise, the borrower's payments increase, and when rates fall, payments decrease. This means the borrower bears the uncertainty and potential financial impact of rate fluctuations. The lender's return is protected because the rate adjusts with market conditions, effectively shifting the risk of rate changes to the borrower who must budget for potential payment increases.
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