When buying a home and seeking a mortgage, borrowers typically are faced with choosing a 15...

When buying a home and seeking a mortgage, borrowers typically are faced with choosing a 15 year or 30-year mortgage where the interest rate and monthly payment is fixed for the life of the loan, or a mortgage where interest and monthly payments can change as other rates change. Using the five core principals of money and banking, explain why the interest on fixed-rate loans has historically been higher.

Expert Solution

Interest rate on fixed rate loan has historically have been higher because of these core principles of money and banking-

A. Principle of liquidity management- under liquidity management bank will be continuously receiving the fixed rate of interest even if the market rate of interest has been reduced so they will be having a better liquidity management.

B. Principles of safety- the commercial bank will have to return the deposit to the depositors also so it try to match the fixed loan payments with the fixed deposit payments.

C. Principles of profitability-commercial banks will generally be determining the profits and commissions which are arising out of loans in advance and they are fixing their loan payments in order to maintain a healthy profits over different time period.

D. Principles of loan and investment- the commercial bank will only grant loan to those entities who have regular fixed income so this entity will be regularly paying them with fixed payments and this fixed loans are representing the principal of loan and repayment that will be representing sound creditworthiness on the part of the borrower.

E. Principles of efficiency also been followed by the bank as it will help the bank in remaining efficient by coping up with different economic cycle even if there will be downturn in economy the company will be receiving the payment from the borrower and it will be able to maintain better Net Asset quality.

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