What is a Price Level Adjusted Mortgage (PLAM)
A price level adjusted mortgage (PLAM) is a graduated-payment home loan. The principal adjusts for inflation. Under this unique kind of mortgage, the bank or lender will not change the interest rate but will revise the homebuyer’s outstanding principal based on a broader inflation rate.
BREAKING DOWN Price Level Adjusted Mortgage (PLAM)
With a price level adjusted mortgages (PLAM) lenders receive back the loan principal, a determined interest amount, and an additional price which covers the cost of inflation. Under normal economic conditions, inflation causes the original value of a home to increase over time. This gradual climb can be significant and happens over the course of a decades-long mortgage.
Increases in home equity will usually offset the home's value rise. Home equity is the value of the homeowner’s interest in their home. In other words, it is the real property’s current market value less any liens which are attached to that property.
Under many adjustable-rate mortgages (ARMs), the lender will leave the homebuyer’s unpaid principal fixed but will adjust the rate of interest on the loan based on key market indices. Under a PLAM, the lender essentially reverses that equation. They will leave the interest rate alone but adjust the homebuyer’s unpaid principal periodically based on the rate of inflation.
Before opening the price level adjusted mortgage (PLAM), the homebuyer and lender will reach agreement on how often the lender is to make inflation adjustments. In most cases, adjustments happen monthly. The lender makes these adjustments based on the movements of an appropriate price index, such as the Consumer Price Index (CPI).
Positive Effects of PLAMs
A price level adjusted mortgage offers advantages to both the homebuyer and the lender. The homebuyer can benefit from keeping their interest rate at a consistently low level for the duration of the loan. This low-rate consistency helps to make the mortgage affordable at all stages.
Since the lender doesn’t incorporate expected inflation increases in the mortgage structure up front, the borrower starts out with lower interest rate and monthly mortgage payments than they would find on many conventional mortgages. Also, the borrower will not have to contend with a sudden substantial mortgage increases later on, because the lender will never hike the loan’s interest rate.
The lender benefits from being able to raise the loan balance based on inflation increases. Inflation affects virtually all prices in an economy, over time. Otherwise, and especially on mortgages which span decades, inflation would slowly erode the value of the mortgage payments which the lender receives from the borrower. As the value of the mortgaged house increases and the note remains static, the lender sees less profit from the loan.
The Problem with PLAMs
A disadvantage to price level adjusted mortgages (PLAMs) is that borrowers have less predictable payments. Whenever inflation sends the unpaid principal higher, the bank will revise the borrower’s monthly payment upward as well. This change means homeowners with a PLAM face the prospect of slight monthly increases to their payments for the life of the loan. Everchanging mortgage payments make harder to plan and budget expenses. For this reason, PLAMs are less suited to borrowers living on a fixed income.