Fixed rate or variable rate loan?

With a real estate loan, the borrower usually has the choice between a fixed-rate or a variable-rate loan.

A decisive role in the context of real estate financing: the interest rate structure © Eisenhans,

The interest rate structure is of great importance in the context of real estate financing. With most banks, you can choose between a fixed-rate agreement and a variable-rate loan value. But what is actually the better alternative?

What does fixed interest mean?

In the context of a real estate loan, a fixed interest rate means that the bank guarantees you the offered interest rate for the loan for an agreed period of time. This includes for you a high interest rate security. The lender does not have the possibility to change the interest rate within the fixed interest period. This is true even under the condition that the interest rates on the market would increase significantly, for example. In practice, most credit institutions offer the following periods for a fixed interest rate:

Some banks are even willing to offer a fixed interest rate of 20 years or a so-called full amortization loan. In this case, the duration of the fixed interest rate would be identical to the total term of the loan, so you would have no interest rate risk at all.

It is important to note that the fixed interest rate applies not only to the bank, but also to you. So if you want to pay off your real estate loan during the agreed fixed interest period or make an unscheduled repayment, you are dependent on the approval of the bank. Most often, lenders charge an early repayment penalty in the case, so this action must be well considered.

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What is a variable interest loan?

The second form of interest rate structure in the context of construction financing, in addition to the fixed interest rate, is the so-called variable-rate loan. In this case, the agreed interest rate is not guaranteed to you on the part of the bank, but instead the lender has the right to change this interest rate at any time, even for your loan. This will usually happen when the ECB changes the key interest rate or there are other, major interest rate changes on the capital markets. With a variable-rate real estate loan, you therefore have no interest rate certainty. In the past, this has led to the vast majority of all borrowers opting for a fixed-rate loan. This applies at the latest since the low-interest phase, because here the real estate loan with fixed interest rate is clearly at an advantage.

When should I choose a fixed interest rate?

The fixed interest rate offers itself with a real estate loan especially in a low-interest phase. We have been in such a phase for over five years now, because since then the key interest rate has been at an extremely low level. This in turn has the effect that the banks offer their real estate loans at increasingly favorable interest rates of currently in some cases below 0.8 percent. In the low-interest phase, it is therefore absolutely advisable that you opt for a fixed interest rate – for as long as possible.

You secure the currently very favorable interest rate for a long period in the future, for example for 15 or 20 years. True, the real estate loans with a fairly long fixed interest rate are somewhat more expensive than if you choose to fix the interest for only five years. However, the interest rate differences are only insignificant, so that the advantage of the long interest rate security clearly outweighs the disadvantages.

Tip: In the current low-interest phase, you should definitely choose a real estate loan with a fixed interest rate. Ideally, it is advisable to choose a full amortization loan or at least a real estate loan with a fixed interest rate of at least 10 to 15 years.

When is the variable-rate loan suitable??

The variable interest real estate loan has next to the real estate loan with fixed interest rate quite its raison d'être. Real estate loans with variable interest rates are ideally suited in a high-interest phase. If you were to choose a fixed interest rate then, you would be tying yourself to higher interest rates for a very long time and, in principle, completely unnecessarily. If interest rates fall then, this would not affect your loan.

Real estate loans with a variable interest rate © adrian_ilie825,

However, the situation is different with variable-rate real estate loans: If interest rates are already at a high level, so that interest rate reductions can be expected, you will benefit from this with variable-rate loans. If the interest rate is actually lowered, the bank would have to adjust the interest rate accordingly. Consequently, a real estate loan with variable interest rate is particularly suitable in high interest phase. But even if, for example, at a medium interest rate level it can be assumed that interest rates will tend to fall in the long term, it is a good alternative.

Provision for unscheduled repayment: Variable-rate loan with advantages

Regardless of the current and future interest rate level, the variable interest real estate loan has another advantage. If you already know at the time of taking out the loan that you will probably want to make one or more unscheduled repayments in the meantime, the bank may not charge an early repayment fee for a variable-rate real estate loan. The situation is different, however, for a real estate loan with fixed interest rates. In this case, the bank may even refuse the request for an unscheduled repayment or at least charge an early repayment penalty.

For this reason, it may well be the better alternative to choose a variable-rate loan, especially if it is not possible to calculate clearly from the current interest rate situation whether interest rates on the market will rise or fall in the next few years. You can then make unscheduled repayments free of charge and at any time.

Note: When choosing between a fixed-rate and a variable-rate loan, you should also think about possible unscheduled repayments or the relatively quick redemption of the loan. In the case of a fixed interest rate, you will incur costs in the form of an early repayment penalty, whereas it is usually possible to make special payments free of charge in the case of a variable-rate real estate loan.

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