Mortgage types

Security vs. flexibility

First off, you should ask yourself if you are willing to take on a certain amount of risk if interest rates fluctuate and would like to profit from lower interest rates. Alternately, you might prefer a steady interest rate so you can plan your budget with more certainty.

Fixed-rate mortgage – fixed interest rate and term

With a fixed-rate mortgage you can lock in a very favourable interest rate over the middle to long term; with this type of mortgage the rate remains constant over its term, which can be between two to ten years or even longer. It is thus fixed for the term of the mortgage, so you are protected against any increases in rates. By the same token you cannot profit from dropping interest rates, but the benefit is that you can set up your household budget with certainty.

Refinancing a fixed-rate mortgage

If you would like to redeem your fixed-rate mortgage early, that is to say before its term is up, you can do so only if you pay a surcharge, something known as a prepayment penalty. With a combination of mortgages having different terms you can avoid the situation where you must refinance your entire mortgage all at once when interest rates are high.

Forward mortgage

If you would like to lock down an attractive interest rate for a fixed-rate mortgage now already, you can do so by taking out a forward mortgage. Most banks stipulate a surcharge for the conclusion of such an early contract. As a rule, and depending on the bank, it amounts to between 0.2 and 0.5 per cent. Thus, a forward mortgage is worth considering especially if you expect interest rates to rise and the interest payments would exceed the surcharge.

Fixed-rate mortgage: an overview

Features

• Interest rate remains constant
• Fixed term

Pros

• Protection against rising interest rates
• Allows reliable budget planning

Cons

• Fixed term
• Costs for early redemption

When to consider it

• Suitable when interest rates are low but are expected to rise

Variable-rate mortgage – floating interest rate and term

With a variable-rate mortgage you remain flexible because there is no fixed term, and your interest rate is adjusted according to conditions on the capital market. It is thus best suited as an interim solution because the notice period is short and is normally between three and six months. As a result, you can switch over quickly to another type of mortgage if interest rates seem to be rising. The variable-rate mortgage is also attractive for property owners who are looking for short-term financing because they plan to sell their property in the near term.
The variable-rate mortgage, however, is not terribly transparent; banks themselves determine how they want to adjust the interest rates. Apart from that, in past times when interest rates have been low, variable-rate mortgages have simply been too expensive.

Variable-rate mortgage: an overview

Features

• Floating interest rate
• No fixed term

Pros

• Considerable flexibility
• Advantageous when interest rates drop

Cons

• Rising interest rates lead to higher interest payments
• Lack of predictability and transparency – the bank has total freedom in changing interest rates

When to consider it

• Suitable when lower interest rates are expected
• Well suited as an interim or short-term financing solution

Libor mortgage – floating interest rate, fixed term

Libor stands for ‘London Interbank Offered Rate’ and is the fluctuating interest rate at which banks loan money to each other. A Libor mortgage is based on the Libor interest rate and has a fixed but relatively short term (six months up to five years). When interest rates are dropping, constant or increasing only slightly, the Libor mortgage is the best choice. In fact, it has been the least expensive type of financing since the mid-1990s.
Interest rates are adjusted up and down relatively quickly and in a transparent manner – depending on your agreement, either monthly, every three, six or twelve months – and passed along to the borrower who can profit quickly from dropping interest rates, but can also be impacted by rising rates.
A Libor mortgage is suited for borrowers who are not worried about increasing interest rates. Those who do not want to expose themselves to the risk of increasing rates can reach an agreement with the bank whereby they pay a surcharge and set an upper limit to the interest rate (called the cap). The Libor mortgage is not at all suited when interest rates are rising quickly.

Libor mortgage: an overview

Features

• Floating interest rate
• Interest rate adjusted monthly or every three, six or twelve months depending on the agreement
• Fixed term

Pros

• Often the least expensive type of financing
• Transparent setting of interest rates based on the Libor reference interest rate
• Profit faster from dropping interest rates
• Hedging against rising interest rates is possible thanks to an upper limit (cap)

Cons

• Fixed term
• Rising interest rates lead to higher interest payments

When to consider it

• Suitable when interest rates are low or when they are expected to drop