Fixed or variable rate loans

1 May

Fixed rate definition

In real estate loans, the fixed rate is a rate that does not change over the entire term of the loan. Repayment payments are determined taking into account the borrowed capital, the loan term and the borrowing rate.

This allows to know exactly the total cost of credit.

However, although the fixed rate is pre-defined, maturities may be constant or progressive over the repayment period. In the first case, the monthly payments are identical from the beginning to the end, in the second case, they are reduced at the beginning of the loan to increase each year.

Variable rate definition

Variable rate definition

The variable rate is a flexible rate. It is revised each year, upwards or downwards, according to the Euribor benchmark index. At the beginning of the loan, the variable rate is lower than the fixed rate. However, it may change subsequently in the event of a rise in rates, which impacts the amount of the monthly payments.

Advantages and disadvantages of a fixed rate loan

Advantages and disadvantages of a fixed rate loan

The main advantage of fixed rate credit is to limit risk by avoiding rate hikes throughout the term of the loan.
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The fixed rate is preferred when one commits to a repayment period greater than 15 years, because it offers more security to the borrower than opting for a variable rate.

Indeed, it is noted that in the short term, rate increases are not significant.
The fixed rate has two drawbacks: one lies in the fact that the borrower does not benefit from a rate cut when the Euribor index is low. On the other hand, the fixed rate at the beginning of the loan is much higher than the variable rate.

Advantages and disadvantages of a floating rate loan

Advantages and disadvantages of a floating rate loan

The variable rate offers an interest compared to the fixed rate since it is much more interesting at the beginning of the loan. It allows, in addition, to take advantage of possible rate cuts throughout the credit period.
Another advantage, and not least, in case of rate hikes, it is possible to convert its variable rate loan into a fixed rate loan as long as this clause is included in the contract.

Finally, to limit the rate hike , the banks have put in place a hedging formula which is the capped rate. This can be 1 to 3% depending on the establishment.

During the borrowing phase, the credit rate can never be higher than the initial variable rate plus the capped rate.

The major drawback of the variable rate loan is its level of risk in the event of a sharp rise in interest rates. This is why it is not recommended in the long term. Subscription to a variable rate mortgage is therefore only worthwhile if the borrowing period does not exceed 7 years, a reasonable period that avoids, in absolute terms, excessive fluctuations.