Fixed rate or variable rate mortgages?
Banks can propose two types of mortgages for financing a client’s property investment. Borrowers have the choice between a fixed rate mortgage or a variable rate mortgage. Each option carries different advantages and disadvantages. While fixed rate credit is used more frequently, as it presents a reduced risk, variable rate credit can be advantageous in certain scenarios.
A fixed rate loan or mortgage is a borrowed amount where the rate of interest payable to the provider remains constant, regardless of global inflation rates or economic changes. Unless a credit renegotiation or early repayment occurs, the loan’s rate does not vary. Repayment is made in the form of monthly instalments, the maturities of which may be progressive, modular or constant.
The main advantage of choosing a fixed rate mortgage to finance your property investment project is the security that it guarantees. The investor is aware of both the interest rate and total cost of the mortgage from the outset, in addition to the duration of reimbursement and instalment amounts. In effect, borrowers reduce risk when choosing a fixed rate loan, because the economy may encounter fluctuations, but the rate of the loan remains unchanged.
Variable or adjustable rates are rates indexed on certain short-term market rates such as three-month and one-year Euribor (indexes that correspond to the price at which banks make short-term loans on the financial market). The interest rate is revised periodically according to how the indices change, this generally takes place annually on the date that the loan was signed for. Banks then add a margin of between 1% and 3% according to the borrower’s profile (professional and family situation, down payment, duration of loan, age of borrower).
In choosing a variable rate loan to finance a property asset, the investor cannot know the total cost of the loan in advance, as it will depend on future interest rates. The rate can become higher or lower, thus increasing or reducing the total cost of credit.
Variable rate loans present therefore the risk of seeing their interest rate increase sharply. This risk can, however, be reduced by the presence of safeguards such as upper and lower limits (a cap). With a cap system in place, the interest rate is variable, but only within certain parameters (both high and low). This cap can be 1%, 1.5% or 2% according to the borrower’s profile.
The main benefits of variable rate loans and mortgages are: lower starting rates than fixed rate counterparts, the possibility of capitalising on a drop in interest rates (especially during a time of high fixed rates), the ability to pay back your loan early without penalty and the ability to transform the variable rate into a fixed rate.
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