Fixed rate period: what is the sensible thing to do?
The decision whether or not to fix the interest rate, and if so, for which period of time, is perhaps the most difficult decision when financing your home. In this article, we have outlined the possibilities and the financial implications. Furthermore, we will help to get you started with four questions you can ask yourself in order to help you make the proper decision in regards to the fixed rate period.
Fixed interest rate
With a fixed mortgage interest rate, you are ensured of stable monthly costs during a fixed and agreed upon time period. Currently, the interest rates are historically low in The Netherlands. This provides the possibility to secure your interest rate for a long period of time at a relatively low percentage and ensures that you have affordable monthly costs at an acceptable interest rate. However, the disadvantage of securing the interest rate is that you cannot switch your mortgage to a new scheme with a lower interest rate or other conditions without having to pay a penalty.
Variable interest rate
With a variable interest rate, you are not protected against interest increases. However, you can benefit if future interest rates decrease. This can result in noticeable changes in your monthly costs. Will you be able to cope with the fluctuations in interest rates if the monthly costs (substantially) rise in the future? And how would you handle an increased interest rate?
It is sometimes suggested that a variable interest rate is cheaper than a fixed interest rate. This is usually the case when you finalise your mortgage and during the initial period. However, it remains to be seen if a variable interest rate is, on average, lower than a fixed interest rate over the entire mortgage term. There is no telling what the interest rate will do and what your monthly costs will be. It therefore depends on your attitude towards risk and your financial situation.
Ask yourself the following questions:
The longer your interest rate is fixed, the more it costs. You are, after all, buying more security. It is naturally a waste to pay unnecessary costs. Will it cost you more in the long run? What is the best course of action? When determining the best period, it might help to ask yourself these four questions:
1. Am I capable and do I want to bear a potential increase in costs?
A few months before your fixed interest rate term ends, you will receive a new proposal from your lender. This proposal includes new possible fixed interest rate periods with new corresponding interest rates. The interest rate may be higher than you are accustomed to paying. What will happen if the interest rate increases at the end of the determined fixed period? We will illustrate this with an example.
Assume that you have the options of 5 years fixed for 4,5% and 5,0% for 10 years fixed. And let’s assume that the 5-year interest rate from year 6 is 6,0%. Then in this table you can see what your payments will be:
|Mortgage €300.000||Current interest rate||Monthly payment initial (gross)||Rate after 5 years||Monthly payment after 5 years (gross)|
Fixing the interest rate for a period of 10 years initially costs you € 90 per month more in the first 5 years. This is a total of € 5400 in the first five years.
After that, in the example, the monthly cost goes up to €1.762. This is €242 per month more than in the first five years.
Are you prepared to pay this potential increase? Even more important: can you cope with this potential increase financially?
In some cases it can be interesting to switch to a different mortgage provider that offers a better deal. You can always ask us to compare the proposal of your current mortgage lender with other lenders.
2. How long do I think I will live in the house?
If you are planning to live in your home for a long period of time, there is a significant chance that you will benefit from securing your interest rate for a longer period of time (based on an increasing interest rate). If you move or sell the house, the mortgage is always repaid at that point in time. If you sell your house after a period of 5 years with a fixed interest rate for a period of 20 years, you may have paid a higher interest rate than needed.
Often enough, an entirely new loan is taken out for a new house. However, in some cases you are allowed to transfer the interest rate conditions you had with your previous lender to the next house. This possibility is interesting if the interest rates have increased in the interim period. In order to transfer the interest rates, you have to stay with the same lender and might also have to borrow an additional amount required for a new mortgage from this lender. It remains to be seen if this mortgage lender is the best party to finance your next house. We can explain the rules for transferring the interest rate conditions in your situation in more detail.
3. Should I take out a loan for the maximum possible amount?
Do you wish to borrow as much money as possible based on your income? Then take the notional interest rate into consideration, which is determined by the AFM (Netherlands Authority for the Financial Markets). This is the interest rate that lenders have to take into account when calculating the maximum borrowing capacity.
However, for a fixed interest period of 10 years or longer, the actual interest rate may be used for calculations. As this interest rate may be significantly lower than the notional interest rate, you are able to borrow more. Our online calculation tool automatically takes this into account and gives you a good indication of your maximum borrowing capacity.
Do you still have insufficient borrowing capacity? One of our advisors can help you to find an optimal match between interest rate and borrowing capacity.
4. Will I make many additional principal payments?
If you fix your interest rate for a period of 10 years and you repay your mortgage in 10 years’ time (gifts, bonus, etc.), it is not sensible to secure your interest rate for a period of 20 years.
5. What if I want to increase my mortgage in the future?
Perhaps you have plans to renovate or make your new home more sustainable in the future. This can be done by using your savings, but you can also increase your existing mortgage: this way you’ll have extra money to spend on your renovation plans. You should take the consequences for your mortgage interest into account however:
- Your monthly mortgage payments will increase, and your mortgage will sometimes be indexed in a different rate category, which will affect the interest rate.
- Have you fixed your interest rate for 10 years, but are looking to increase your mortgage after 2 years, for example? If so, when determining your borrowing capacity, the remainder of your fixed-rate period is taken into account, which is 8 years. This is shorter than 10 years, which means that for safety’s sake, you assume the AFM notional interest rate of 5% for the calculation. This is a lot higher than the actual interest rate. Your total borrowing capacity will be lower as a result. Are you already sure during the process of buying your home that you’ll be looking to increase the mortgage? If so, it’s smart to immediately fix the interest rate for a longer period, for example for 15 or 20 years.
We will gladly assist you in choosing a fixed interest period and other choices you have to make when financing a house.
Would you like to know more about interest rates? Take a look at our mortgage proposal guide. If you would like to speak with an expert advisor, please feel free to schedule an appointment with one of our advisors.
Download white paper ‘Buying a home in The Netherlands’
Do you want to go on a home hunt well prepared? You will find all the information in this white paper.