Introduction

When you think about mortgages, you usually imagine fixed or adjustable rates. But have you heard of a Price Level Adjusted Mortgage (PLAM)? This type of loan adjusts based on inflation, helping protect both lenders and borrowers from unexpected price changes.

In this article, we’ll explore what a PLAM is, how it works, and why it might be a smart choice in certain economic conditions. Understanding this can help you make better decisions about your home financing.

What Is a Price Level Adjusted Mortgage?

A Price Level Adjusted Mortgage is a type of home loan where the principal balance changes according to inflation or a price index. Instead of a fixed amount, the loan amount is adjusted periodically to reflect changes in the cost of living.

This means that if inflation rises, the outstanding mortgage balance increases, and if there is deflation, it decreases. The interest rate on the loan is usually fixed, but the principal amount changes with the price level.

How Does a PLAM Work?

PLAMs link the mortgage principal to a price index, such as the Consumer Price Index (CPI). Here's how it typically works:

• The original loan amount is set at the start.

• At regular intervals (often yearly), the principal is adjusted based on the change in the chosen price index.

• Borrowers pay interest on the adjusted principal, not the original amount.

• Monthly payments may vary depending on the adjusted principal and fixed interest rate.

This structure helps maintain the real value of the loan over time, protecting lenders from inflation erosion and borrowers from unexpected interest rate hikes.

Benefits of a Price Level Adjusted Mortgage

PLAMs offer several advantages, especially in inflationary environments:

• Inflation Protection for Lenders:

  The loan’s real value is preserved, reducing risk.

• Potentially Lower Initial Payments:

  Since interest rates are fixed and principal adjusts, initial payments can be lower than traditional loans.

• Transparency:

  Payments reflect actual economic conditions, making it easier to understand real costs.

• Reduced Interest Rate Risk:

  Borrowers avoid sudden spikes in interest rates common with adjustable-rate mortgages.

Risks and Considerations

While PLAMs have benefits, they also come with risks:

• Payment Uncertainty:

  Because principal adjusts with inflation, monthly payments can increase unexpectedly.

• Deflation Impact:

  In rare deflationary periods, the principal and payments may decrease, which can be confusing for borrowers.

• Limited Availability:

  PLAMs are not widely offered by lenders, limiting options.

• Complexity:

  Understanding how adjustments work requires careful attention to the price index and timing.

Who Should Consider a Price Level Adjusted Mortgage?

PLAMs might be suitable if you:

• Expect moderate inflation and want protection against rising costs.

• Prefer a fixed interest rate but are comfortable with principal adjustments.

• Are financially savvy and can manage variable payments.

• Want to avoid the risks of traditional adjustable-rate mortgages.

However, if you prefer payment stability or have a tight budget, a traditional fixed-rate mortgage might be better.

How Does a PLAM Compare to Other Mortgages?

Here’s a quick comparison:

• Fixed-Rate Mortgage:

  Principal and interest fixed; payments stable but no inflation protection.

• Adjustable-Rate Mortgage (ARM):

  Interest rate varies; principal fixed; payments can fluctuate with rates.

• Price Level Adjusted Mortgage:

  Interest rate fixed; principal adjusts with inflation; payments vary with principal.

PLAMs combine features of fixed and adjustable loans, offering inflation protection without interest rate risk.

Practical Example of a Price Level Adjusted Mortgage

Suppose you take a $200,000 PLAM with a 5% fixed interest rate. If inflation is 3% after one year, your principal adjusts to $206,000 ($200,000 + 3%). Your interest is then calculated on $206,000, increasing your payment slightly.

If inflation drops or deflation occurs, the principal and payments adjust downward accordingly. This keeps the loan’s real value stable over time.

Conclusion

Price Level Adjusted Mortgages offer a unique way to handle home loans in changing economic conditions. By linking the principal to inflation, they protect lenders and borrowers from the risks of price changes.

While not for everyone, PLAMs can be a smart choice if you expect inflation and want a fixed interest rate without surprises from rate hikes. Understanding how they work helps you decide if this mortgage fits your financial goals.

FAQs

What index is used to adjust a PLAM?

Most PLAMs use the Consumer Price Index (CPI) or a similar official inflation measure to adjust the principal balance periodically.

Are PLAM payments fixed?

No, payments vary because the principal adjusts with inflation, but the interest rate usually remains fixed.

Can PLAMs protect against deflation?

Yes, in deflation, the principal and payments decrease, though deflation is less common and can be confusing for borrowers.

Are PLAMs widely available?

PLAMs are less common than fixed or adjustable-rate mortgages and may not be offered by all lenders.

Who benefits most from a PLAM?

Borrowers expecting moderate inflation who want fixed interest rates and can handle variable payments benefit most from PLAMs.