FAPs are financial derivatives conceptually equal to interest rate insurance . We know that if we hire them, the interest rate on our mortgage loan will not rise by a certain value for a term and we will also benefit from the declines. In return we pay a single premium at the beginning of the loan.
It will be implemented through a policy generally issued by a financial entity and we will pay a premium for it, which will be our total cost for this operation.
However, our benefit will be unlimited in case of rate hikes , as it will be marked by the difference between the reference interest rate on future dates and the strike or strike price. In this case we would receive periodically on the dates of the settlement income for the difference.
In case of a reduction below the agreed rate we would benefit from it.
Simplifying, we can say that a FAP :
- It is a financial derivative , an option specifically, which is acquired independently of the mortgage loan (although it can be marketed as a pack).
- An exercise price is established, which simplifying is the interest rate to which the rise of the Financial Standing is to be limited (for example, it is ensured that it does not rise above 3%).
- A term is agreed; for example, one is protected from the rise of the Financial Standing for 5 years.
- A certain nominal amount is secured, which can be the total mortgage loan or less.
- In exchange for protecting against the increases in the Financial Standing (and benefit from the decreases), the customer has to pay a single premium when contracting the product (and the mortgage if done jointly).
Equal to interest rate insurance
The FAP, therefore, is conceptually equal to interest rate insurance , which has a cost that assures us in case of increases in the Financial Standing and allows us to benefit from the declines. It is necessary to contract it with the due advice of professionals in the matter, since it is a complex financial product. Do not confuse with the controversial Swaps, which do not allow us to benefit from the Financial Standing drops.
It is a recommended instrument mainly when we find low interest rates and a foreseeable upward trend.