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 crucial role in the context of real estate financing: the interest rate © 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 interest rate agreement and a variable interest rate loan value. But what is actually the better alternative?

What does fixed interest rate mean?

In the context of a real estate loan, a fixed interest rate means that the bank guarantees you the interest rate offered for the loan for an agreed period of time. This provides you with a high level of interest rate security. The lender does not have the possibility to make a change in the interest rate within the fixed interest period. This is true even under the assumption that interest rates on the market would increase significantly, for example. In practice, most lending 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.

Fixed interest rate reduces interest rate risk in follow-up financing © VRD,

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 bank's approval. In most cases, lenders charge an early repayment fee in this case, so this action must be well considered.


What is a variable interest loan?

The second form of interest rate structure in the context of construction financing is, in addition to the fixed interest rate, the so-called variable interest 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, also for your loan. This will usually happen when the ECB changes the key interest rate or there are other, major interest rate changes in the capital markets. Consequently, with a variable-rate real estate loan, you have no interest rate certainty. In the past, this has meant that the vast majority of all borrowers have opted for a fixed-interest period. This has been true at least since the low-interest phase, because here the real estate loan with a fixed interest rate has a clear advantage.

When should I choose a fixed interest rate?

The fixed interest rate offers itself with a real estate loan in particular in a low-interest phase. We have been in such a phase for more than five years now, because since then the key interest rate has been at an extremely low level. This in turn has the effect that banks are offering their real estate loans at increasingly favorable interest rates of currently less than 0.8 percent in some cases. In the low interest rate phase, it is therefore absolutely recommended that you opt for a fixed interest rate – 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. Although real estate loans with a fairly long fixed interest rate are somewhat more expensive than if you opt for a fixed interest rate 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 repayment loan or at least a real estate loan with a fixed interest period of at least 10 to 15 years.

When is the variable interest loan suitable??

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

Real estate loans with a variable interest rate © adrian_ilie825,

The situation is different for 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 interest rates are actually lowered, the bank would have to adjust the interest rate accordingly. Accordingly, a real estate loan with a variable interest rate is particularly suitable in high-interest phases. But it is also a good alternative if, for example, interest rates are expected to fall in the long term at a medium level.

Unscheduled repayment planned: variable-rate loan with advantages

Regardless of the current and future interest rate level, the variable-rate real estate loan has another advantage. If you already know at the time of taking out the loan that you will in all likelihood want to make one or even several unscheduled repayments in the meantime, the bank may not charge an early repayment penalty in the case of a variable-rate real estate loan. However, the situation is different for a real estate loan with fixed interest rate. 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 a better alternative to choose a variable-interest loan, especially if it is not possible to clearly calculate from the current interest rate situation whether interest rates on the market will rise or fall in the next few years. Unscheduled repayments can be made at any time and free of charge.

Note: when choosing between a fixed interest rate and a variable interest rate loan, you should also consider 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 with a variable-rate real estate loan it is usually possible to make special payments free of charge.

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