A SWAP loan (also called an interest rate swap) is a financial contract concluded between a bank and a cooperative housing association. Swap is an English word that translates to Danish meaning swap. In fact, this is exactly the case for a SWAP loan. Namely, an interest swap is made between the two parties involved.
Fixed interest rate
If a cooperative housing association has a Flex loan, then it is possible for this association to enter into a contract (what is called an interest rate swap) with the bank if they would like a fixed interest rate instead. The association still retains its Flexible Loans at a variable interest rate, but the bank is at risk for interest rate increases.
However, the bank will also be able to score a profit if the variable interest rate on the Flex loan stays at a lower level than the interest rate on the loan with a fixed interest rate which the association has committed to pay to the bank. Therefore, such an agreement may prove to be both good and bad business for both parties.
If an interest swap agreement has been made between a cooperative housing association and a bank, then an agreement has also been made to make an interest swap. Therefore, the association simply has to pay the fixed interest rate they have agreed with the bank, while the bank will, on the other hand, pay the variable interest rate that is on the Flex loan.
Pros and cons of interest rate swaps
There are both advantages and disadvantages to making an interest rate swap. Therefore, it is also something that must be considered very carefully before throwing yourself into it. It is an advantage for a cooperative housing association that they can remove the risk they have for interest rate increases, as it is the bank that takes this risk if they choose to make an interest rate swap.
In contrast, the fixed interest rate payable to the bank is often quite high. It is also higher than the interest rate on the variable loan. What this means is that you have to pay some kind of tax to the bank, to get a loan where you are not hit by interest rate increases – and therefore do not have to take into account a variable repayment.
However, it is very normal for this to happen. If you have to take out any loan with a fixed interest rate, then that interest rate will also be higher than on a Flex loan or a mortgage loan. Therefore, an interest rate swap is largely just like taking out a fixed-rate loan as a cooperative housing association, instead of their variable loan.
However, there are two significant differences. The interest rates are not always the same on the two products. If you get an interest rate in an interest rate swap that is lower than the interest rate that can be obtained by choosing a fixed rate loan, then of course it will seem like a good deal for the cooperative housing association, but there is also a disadvantage to this.
An interest rate swap is not convertible
The aforementioned disadvantage is that a SWAP loan is not convertible, which otherwise applies to the vast majority of fixed-rate loans. When a fixed-rate loan is convertible, it really means that you as a homeowner can be lucky to score a profit if the interest rate either says or drops substantially.
Since it is not possible to convert an interest rate swap, it is not possible here. Instead, you are subject to the same contract and agreement with the bank until it expires. Therefore, it is also something that as a cooperative housing association must be aware of before choosing to make an interest rate swap.
If you can get an interest rate on an interest rate swap that is a lot lower than on a fixed rate loan reminiscent of interest rate swaps, then it would make good sense to do so. It can easily prove to be a solution that is significantly cheaper for the cooperative housing association than having a fixed-rate or variable-rate loan.
Disadvantages of making an interest rate swap
If you are part of a cooperative housing association that is considering making an interest rate swap, then you should be aware that there are some drawbacks to the choice. They have already been elucidated a bit over here, but it is a particularly good idea that you are thoroughly acquainted with what these disadvantages may actually mean to the borrower.
As previously stated, there are two disadvantages of an interest rate swap compared to a fixed rate loan. There are two disadvantages that have arisen as a result of a loan that is not convertible. As a result, so …
- … You cannot be allowed to repay the loan ahead of time. You therefore have to wait until the end of the loan.
- … Interest rates cannot be used to reduce the size of the loan. In addition, interest rate cuts cannot be used to achieve a lower interest rate.