Floor clause

A floor clause is the minimum limit on the interest rate  to be paid in the installments of a  real estate mortgage . It is the opposite of the roof clause.

When the interest rate of the benchmark used for calculating mortgages ( Euribor or Libor for example) falls below the point established as land, the interest rate charged by the entity is land.  For example, if the land established is 1% and the interest falls to 0.5%, the entity will continue to charge 1%.

This limit is established by some credit institutions as a protection mechanism against possible declines in interest rates. It is a practice considered abusive in some countries. In Spain it is considered illegal if it has not been explained with sufficient transparency by the financial institution .

This land clause affects mortgages contracted at  a  variable interest rate, since in those contracted at a fixed rate the interest throughout the life of the  loan  will remain constant over time.

Operation of a  loan  at  interest rate  Variable

When a variable rate mortgage is contracted with a credit institution, it sets an interest rate which it will charge for having lent that money. Two elements are involved in fixing this interest:

  • The  interest  rate of the reference index for the calculation of the  mortgage . This is determined by the  interbank market  and is the interest that the credit institution pays to obtain the   necessary liquidity to grant the loan (it is subject to variations throughout its life).
  • A differential that the credit institution charges the  mortgage contractor . This is determined by the entity itself and is the profit margin that the entity obtains when making the mortgage loan (it is fixed throughout its life). For example, the index plus 2%.

Why is a ground clause fixed?

If the reference interest rate of the  mortgage  decreases over time and in addition the agreed differential is low, the interest payment could be close to 0 or even fall into negative territory, being the banking entity itself that pays the client for lending the money.

In reaction to this hypothetical situation and as a  mechanism to safeguard the interests of credit institutions,  these ground clauses arise . By fixing them in the mortgage contract, credit institutions thus protect themselves from possible falls in the variable part of the loan granted. In this way, the land clause aims to prevent credit claimants from paying too low interest on their mortgage, not paying interest on it, or receiving money for having taken out the mortgage in a utopian situation.

by Abdullah Sam
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