Basics of variable loans
Every real estate financing typically consists of two pillars: equity and debt. The borrower contributes the equity themselves, in the form of savings or existing property. The debt—the difference between the total costs to be financed and the available equity—is usually provided as a mortgage loan by a lender. The classic types of these mortgage loans are the hypothecary loan, the annuity loan, or the variable-rate loan.
The variable loan — its advantages and risks
The difference between a hypothecary loan and a variable-rate loan lies in how the interest rate is determined. With a hypothecary loan the interest rate is fixed for a certain term and specified in the contract; with a variable-rate loan this interest rate is linked to the EURIBOR. The EURIBOR is the reference interest rate at which 44 European banks lend money to one another. It is published daily on the business pages of reputable newspapers or on the internet. Based on this money market rate, the interest rate for the variable-rate loan is determined for the next three months. In other words, the rate is reset every three months. A variable-rate loan is an alternative to long-term fixed interest. This type of flexibility is attractive to borrowers who want maximum flexibility. The nominal interest rate of the loan therefore applies only for the next three months. That means if interest rates fall during this period, the rate for the variable loan also decreases, allowing borrowers to benefit quickly from such cuts. Conversely, if rates rise during that period, the rate on the variable loan will increase. The monthly installment therefore consists of the variable interest rate plus a fixed repayment portion. At the same time, the advantage of this loan is that it can be terminated within those three months without incurring a prepayment penalty. A variable-rate loan can also be repaid in full or in part at the interest rate change date. This means that saved funds or any newly available assets can be used at any time to reduce the loan. Before taking out such a loan, the different processing fees and creditworthiness surcharges of lenders should also be compared.
Who benefits from a variable loan and when it is used
Every real estate financing arrangement is highly individual. Accordingly, it can be structured by both the lender and the borrower to suit individual needs. For example, if only short-term financing is needed, a variable-rate loan can be advantageous. If the borrower expects a larger sum of money in the foreseeable future, the variable loan can be used as bridge financing. It may also be advisable if further significant interest rate cuts are anticipated. If interest rates have fallen sharply and further cuts are not expected for the time being, it is possible to convert this variable loan into a fixed-rate loan. It is essential with a variable loan to constantly monitor the interest rate market. As quickly as rates can fall, they can also rise again. The risk of interest rate changes should always be taken into account. If rates rise, monthly interest expenses can quickly reach a level that poses a risk to the borrower and may no longer be affordable. Borrowers who prefer security should think carefully before choosing this type of loan. For them, a fixed-rate loan—where the interest rate is fixed at contract inception for a certain period—is a safer alternative.
The variable loan in combination with an annuity loan
It is perfectly normal in real estate financing for the debt portion to consist of several loan components. Partially variable loans can therefore also be used. This form of financing consists of a variable-rate loan and a fixed-rate annuity loan. In this case the variable loan is tied to the reference rate, the EURIBOR, while the fixed-rate loan has conditions fixed by an interest lock-in. This combination has its advantages. In the fixed-rate loan the interest is bound, meaning the risk of interest rate changes is reduced. At the same time the variable loan allows participation in falling interest rates, thereby potentially lowering interest payments significantly. Special repayments can also be made on this part of the partially variable loan without incurring a prepayment penalty. The borrower can generally decide how large the share of the fixed-rate or variable loan should be in relation to the total loan amount. The variable portion is not tied to a fixed term. For the fixed-rate loan, the term and interest rate are specified in the loan agreement. The interest depends on the general level of interest rates. For security of the creditor, both in a partially variable loan an entry in the land register serves as collateral. Both the variable loan and the fixed-rate loan are usually entered as first-ranking entries. Due to the interest rate change risk associated with the variable loan, the lender will consider the credit risk and whether the borrower still has sufficient margin to meet their loan obligations even if the interest rate rises.
The advantages of this financing method
With this kind of real estate financing you can calculate with certainty while at the same time participating flexibly in market developments. At the same time the borrower brings stability into the financing. This combined loan offers a lot of flexibility through the quarterly special repayment option. You also always benefit from an interest rate reduction by the European Central Bank. The frequent conversion to a long-term fixed interest period can also be attractive. This combined loan is an ideal solution for borrowers who expect the European Central Bank's key interest rates to fall. It also suits borrowers who want to make frequent use of their special repayment options. Through this increased repayment the variable loan can be paid off very quickly. It is therefore always worth considering how large the share of the partially variable loan should be. Combinations such as 70:30 or even 50:50 between the fixed-rate loan and the variable loan are not uncommon. When considering the fixed-rate period, it should also be noted that, in principle, any loan with a fixed-rate period can be terminated free of charge after 10 years. This also applies if the fixed-rate period exceeds those 10 years. Note that the notice period is six months. After 10 years a completely new financing model can thus be established.