Loan conversion is a word that comes up in connection with mortgages. It is not possible to convert other loan types.
A mortgage loan is based on bonds that can be either fixed-rate or floating-rate. For more description about mortgages, see here.
A loan conversion is also called a loan conversion, which actually describes it a little better. Loan restructuring means that you repay your loan, ie repay the old loan and take out a new one.
There may be several reasons to restructure your loans, but all have in common that there is an economic carrot associated with it.
There are 3 types of loan conversions, which are:
- Chewing Conversion
A loan conversion is done by raising a new loan with a higher interest rate. It sounds completely wrong on paper to want a higher interest rate, but there is a point to the madness.
In the world of mortgage credit, there are two very important concepts, namely interest and exchange rate.
The interest rate is the price to borrow the money. A percentage of the outstanding debt you pay each month.
The rate is the price of the loan itself. If you take out a mortgage loan of DKK 1 million. at rate 98, you only get paid 980,000 kroner even though the debt is still 1 million kroner.
What one has to understand here is that it is so related that when interest rates rise, the price falls and vice versa.
Therefore, after a period of rising interest rates, it may be worthwhile to switch to a higher-interest loan. Follow here:
If interest rates have risen, the price has fallen.
If you pay off your old loan (Most loans pay off at par, which means rate 100).
To make it more edible, the outstanding debt on your loan is $ 1 million. kr.
So you pay off by paying 1 million. dollars that you take out a new loan to finance. But as the price drops, let’s say 95, your outstanding debt will be shaved down to $ 950,000 instead of a $ 1m.
In order for a conversion to respond, the additional interest payments must not exceed the amount by which you reduce the outstanding debt.
The whole idea of converting is to shave off some of its residual debt. This is a reasonably speculative loan restructuring, as you usually up-convert to down-convert later. More about Down conversion now.
Downconversion, as you might have guessed, means to do the opposite when converting.
One should downgrade after a period of falling interest rates.
You are therefore repaying your loan at a higher interest rate than the general interest rate, in order to take out a new loan with the lower interest rate.
Your interest payments and thus your monthly payments will thus be reduced.
However, be aware that the interest rate gain you make must exceed the cost of rescheduling the loan.
The costs of restructuring the loan are various fees and foundation costs, as well as probably increasing the outstanding debt as the rate has risen.
Oblique conversion is the most rare type of conversion.
Slant conversion involves converting your fixed-rate mortgage into a variable interest rate. It may also be the other way around, but it is, as is often the case.
A slant conversion is a very speculative loan restructuring as you “gamble” that interest rates fall. By switching to a floating rate loan just before the interest rate falls, your interest rate will go down (That’s what a variable rate loan does).
However, if interest rates rise, your interest rate will follow and you will have to pay a higher benefit.