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More and more I hear about people taking a mortgage fixing their interest rate for 30 years. I was always suggested that this would not be wise, but as always – my knowledge was limited at the time when I made a decision, and interest rates have really made a drop in recent times. So let’s have a dive into what are the factors to consider when deciding to fix (or not) your mortgage interest rate(s).
“The cost of stability is often diminished opportunities for growth.”
– Sheryl Sandberg
This article is part of a series on the basic variables important in a mortgage:
- Loan amount
- Loan term
- Mortgage types
- Fixing the interest rates
- Tax benefits
- Mortgage insurance
- Other obligations (loans, alimony)
I will of course attempt to include as many different financial philosophies along the way, although this is a topic where I cannot avoid regional specificity when it concerns rules and regulations that apply to various parts of this discussion.
However, as the majority literature references the U.S. situation, I will balance this with providing the U.S. situation next to the Dutch situation (to the best of my capacity). Hopefully you can enjoy and learn a lot during the way – I know I will!
Fixing interest rates
Interest rates can be fixed for various difference periods in the Netherlands, compared to the U.S. where it seems you have to choose to either have a fixed-rate or adjustable-rate for the entire term. Given the choice would you fix your interest rate for 10, 20, 30 years or only 1 or 5 years? Or do you feel that interest rates will only drop from now on and you feel like taking on a variable interest rate, which, different than the U.S. adjustable-rate, will go up or down every month depending on the current market rates for as long as you don’t have a fixed-rate (as I understand it).
As with the discussion on the term of your loan, fixing interest rates is a matter of risk-aversity – fixing for 30-years gives an absolute security on how much you’ll pay for your entire mortgage, while forfeiting the benefit of any decrease in interest rates. Variable rates on the other hand will usually be lower than any fixed rate.
Let’s differentiate first between <10 years, compared to ≥10 years. What you’ll find (in the Netherlands) is the size of the loan you can take out can be considerably different. This is because, starting at year 10 mortgage lenders can calculate with the actual interest rate – whereas below 10 years, by law, they are forced to calculate with a government (AFM) mandated interest rate (‘toetsrente’ in Dutch), which is at least 5%. As you can imagine this can make a big difference in a time where interest rates hover around 1%. The 10-year period is also one of the most popular choices, probably due to the lowest interest rates – however in de current situation the difference in interest rates is disappearing more and more, and therefore also the 15– and 20-year periods are gaining in popularity.
As with the duration of your mortgage, let’s compare the pros and cons of taking a short – or a long duration of the fixed interest rate – where the short is talking about at least 10 years (i.e. 10 to 15 years) and the long is talking about 30 years max (i.e. 20 to 30 years).
As with the duration of your mortgage, I don’t necessarily feel that the size of the mortgage you qualify for is necessarily good or bad – it should depend on what you want to pay (not what you can get).
Overall, it is a clear picture that, in general, a shorter period of fixing your interest rate is more attractive. Studies have even found that over time, the borrower is likely to pay less interest overall with a variable rate (following the Euribor, and not fixing it all) versus a fixed loan rate – however, with the interest rates as low as today, I would not like to suggest that observations in the past are a good indication of the future.
With the increased cash flow that the lower interest rate generates in a shorter fixed period, as with the extended duration of your mortgage, you could pay off extra on your mortgage in order to reduce the risk of the interest increasing to decrease the impact of the biggest negative of this option.
If the shorter fixed period has so many positives, when would you NOT take this option? This depends mainly on the stability and size of your income. If you can barely make the monthly payment, you’ll have insufficient buffers to carry a potential increase in interest rate, similar if your mortgage is determined on a double income and one income is reduced or lost. Emergencies are created when you can’t handle them – therefore these might be circumstance to forego some benefits and go for more security on the long term. Do consider first how long you are intending to stay in this home, on average, Dutch people move 7 times in their lifetime and fixing the interest rate for 30 years while selling the house in less than 20 years is just taking a high interest rate for no reason – as usually you won’t take the same mortgage with you to the next home.
Some financial planners are suggesting to use a mix of different periods to spread out the risk, for instance one part fixed for 2 years, another for 10 – and yet another for 20 years. A period that is suggested to benefit you – however, my personal opinion is that a good financial strategy is a simple one, an opinion supported by several experts on millionaire strategies. But as always – speak to a financial advisor about your specific conditions.
How long did you fix your mortgage for? Are you regretting this decision or did you think you followed some good advice?
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