When you define your financing plan, you will have to decide between a fixed or variable interest rate. Etienne Planchard, Member of the Management Committee and Head of Loans and Credit, describes the respective benefits and disadvantages of each option.
Good for stability...
Fixed rate – as the name implies, fixed-rate mortgages remain unchanged during the agreed term of the loan. A fixed rate is generally higher than a variable rate but its main advantage is security. The borrower will know from the outset what the monthly repayments will be and the total cost of the mortgage. Even if the market fluctuates significantly, the mortgage costs will stay the same. The cost of borrowing is therefore contained.
A fixed rate can seem particularly attractive in the current phase of historically low interest rates since it is relatively close to the variable rate of the last 20 years. However, it is slightly higher if you factor in the cost of financing over time.
... but less flexible
A fixed rate is attached to a predefined repayment schedule: if the schedule is changed for any reason, including early repayment, the existing plan has to be terminated. This entails a cost for the bank which also has to terminate the corresponding cover. A penalty will be applied to the borrower for early partial or full repayment of the loan: for example, if the property is sold before the loan matures.
A variable rate is an interest rate which can fluctuate up or down according to market conditions and the principles governing the loan.
A variable offers a number of advantages. It means you can:
- Repay the mortgage with or without a predefined amortisation plan, which could be useful as it enables the investor to make repayments at his own pace. This makes particular sense if the borrower does not have a regular income (e.g. for people who do not have a regular salary so they cannot be sure of a constant cash flow).
- Make fee-free early repayments. A variable rate allows for early repayments without penalty. This means you can shorten the term of the mortgage or decrease the monthly payments without paying a fee.
- Have a "drawdown" account: if you are building a property, the bank will release the necessary funds as the construction work progresses. Interest will only be payable on the portion of the loan which is used, not on the entire mortgage amount. This saves the borrower from paying unnecessary interest on the unused portion.
... but it means taking a risk and having less certainty
Opting for a variable rate is a speculative measure. The borrower cannot predict in advance what the monthly repayments will be in the years to come or how long it will take to repay the mortgage. The borrower could be exposed to rising interest rates if the markets fluctuate.
Do you have to choose?
There are numerous configurations according to individual parameters. It is also possible to opt for a scenario that combines periods of fixed and variable interest rates: for example, choosing a fixed rate for a limited period of 5-10 years and then reviewing the situation according to the markets and your personal and professional situation at that time. The financing rate varies according to the amount borrowed, your repayment capacity and the guarantees given.
As every situation is different, our credit specialists analyse all the tax, asset, financial and personal aspects to ensure that the solution they offer is ideal for your individual situation.
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Further publications about investing in property coming soon on the blog.