Fixed rate or variable rate

The fixed rate

As its name implies, the loan rate is defined when you sign the contract and doesn’t vary unless you repay the loan before maturity or renegotiate it.

Maturity dates can however be adjusted time wise. They can be constant, progressive, or adjustable.

• constant maturity date means monthly payment amounts will be the same for the entire loan period
• progressive maturity date means monthly payment amounts will increase every year at a pace determined at the time of signing.
• adjustable maturity date means the borrower can increase or decrease the monthly payment amount according to his/her cash flow. These adjustments are heavily regulated.

The advantage of the fixed loan rate is its security. Regardless of how the market develops, monthly payments and total cost of credit will remain the same (which also means that if rates go down, the borrower will pay more interest than the market dictates).
The inconvenience of the fixed rate is the penalty applied in case of early payment (which can reach 2 or 3% of the principal remaining due)..

The variable rate

The interest rate is adjusted every year according to a reference index.
The advantages of the variable rate are :

• a commencing rate lower than the fixed rate
• the early payment without penalty option
• the freedom to take advantage of a decline in the market
• and finally, the possibility of transforming a variable rate into a fixed rate (if the clause is included in the contract right from the beginning)

The main inconvenience is the risk of a rate increase. To protect customers, banks offer the option of defining a ceiling, a ‘cap’ beyond which the rate cannot rise. This is what is called the capped variable rate. The commencing rate is higher but risk is lower.