What is ‘Price Level Adjusted Mortgage – PLAM’
A price level adjusted mortgage is a graduated-payment mortgage that adjusts for inflation. Under this special type of mortgage, the bank or lender will not change the interest rate but will revise up the homebuyer’s outstanding principal based on a broader inflation rate.
BREAKING DOWN ‘Price Level Adjusted Mortgage – PLAM’
Price level adjusted mortgages allow the lender to be paid back principal and interest plus an amount to cover inflation. Under normal economic conditions, inflation causes the original price of a home to go up over time. That price increase is gradual (and usually dwarfed by increases in home equity), but can be significant over the course of a decades-long mortgage.
Under many mortgages, the lender leaves the homebuyer’s unpaid principal fixed but adjusts 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 initiating the PLAM, the homebuyer and lender will reach agreement on how often the lender is to make inflation adjustments, though in most cases it happens monthly. The lender makes these adjustments based on the movements of an appropriate price index, such as the Consumer Price Index.
Pros and Cons of PLAMs
A price level adjusted mortgage offers advantages to both the homebuyer and lender. The homebuyer can benefit from keeping their interest rate at a consistently low level for the duration of the loan, possibly making the mortgage more affordable at all stages. Since the lender doesn’t incorporate expected inflation increases in the mortgage structure up front, the borrower starts out on a lower interest rate and payments than they would find on many regular mortgages. The borrower also will not have to contend with sudden large mortgage increases later on, since 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 that affect virtually all prices in an economy over time. Otherwise (and especially on mortgages that span decades) inflation would slowly erode the value of the mortgage payments that the lender receives from the borrower.
A disadvantage to PLAMs is that borrowers enjoy less predictable payments. Whenever inflation sends the unpaid principal higher, the bank will need to revise up the borrower’s monthly payment accordingly. That means homeowners with a PLAM face the prospect of slight monthly increases to their payments for the life of the loan, making it possibly harder to plan and budget for. For this reason, PLAMs are considered generally less suited to borrowers living on a fixed income.