Advantages and disadvantages of different mortgage models
Fixed rate, LIBOR, or adjustable-rate? The right mortgage can keep your wallet and your nerves intact. Find out what types of mortgages exist, what advantages and disadvantages they have, and how to decide which mortgage is right for you.
Whether they are buying a home or refinancing an existing mortgage, choosing the right configuration of models can save homeowners a lot of money. Not only is it important to compare and track the development of mortgage interest rates. Understanding the different mortgage models and combining them correctly is just as important, if not more.
Generally speaking, there are three mortgage models: fixed-rate, LIBOR, and adjustable-rate mortgages. Each bank has different subcategories of these three mortgage models with special terms and conditions.
Fixed-term mortgages provide security
A fixed-term mortgage is concluded for two to fifteen years, and occasionally for even longer. Clients agree to an interest rate with the bank that applies for the entire term. This mortgage model is popular among Swiss homeowners because it provides security. Borrowers know exactly what amount they will need to regularly pay the bank for the entire term of the mortgage. This prevents any unpleasant surprises caused by rising interest rates.
Security comes at a price, however. For fixed-rate mortgages, this means slightly higher mortgage interest. With a fixed-rate mortgage, homeowners also commit for the entire term. If they want to pay off a mortgage early – because their house is being sold, for instance – any remaining breakage costs owed must be paid.
Adjustable-rate mortgages provide the most flexibility
An adjustable-rate mortgage is a better choice for anyone looking to sell their house or condo in the near future or to stay flexible for other reasons. It is the only mortgage model with no contractually stipulated term. It is important to pay attention to the notice periods, however.
The interest rates for adjustable-rate mortgages are routinely adjusted to the market, so they may fluctuate considerably. This is not suitable for risk-averse homeowners. Flexibility comes at a price as well: An adjustable-rate mortgage is typically the most expensive mortgage model.
LIBOR mortgages are often the cheapest
One alternative to an adjustable-rate mortgage is the LIBOR mortgage. The interest rate for this mortgage is based on the current LIBOR (London Interbank Offered Rate). This is the interest rate banks use to extend each other short-term loans. As a result, the interest rate is market-oriented. Clients can choose how often their rate is adjusted: every 3, 6, or 12 months.
With a LIBOR mortgage, a term is agreed to just like with a fixed-rate mortgage, except that the interest rate is routinely adjusted. In the past, LIBOR mortgages have been a practical alternative to a fixed-rate mortgage over the entire term. Their interest rates can vary significantly, however, so there is also an option combining the LIBOR mortgage and the fixed-rate mortgage.
Mortgage model advantages and disadvantages
- Protection from rising rates – fixed interest rate
- Able to benefit from particularly low interest rates for longer
- Any drop in interest rates not passed on
- Inflexible due to fixed term – expensive to pay off early
- Any drop in interest rates is directly passed on
- Flexibility: no fixed term, termination possible at any time
- Rising interest rates have direct impact on budget
- Slightly higher interest rates are the price to pay for the flexibility
- Switch to a fixed-rate mortgage possible once each tranche expires
- If the LIBOR drops, so does the mortgage interest
- If interest rates rise, the mortgage is suddenly more expensive
- Interest rates may fluctuate considerably
Choosing the right mortgage model
In conclusion, there are good arguments for every mortgage model. Which one is right for you depends entirely on your personal situation. It is especially important to find a balance between security, flexibility, and cost. For instance, while a couple with two incomes may prefer a LIBOR mortgage, a family with limited income may choose a conventional fixed-interest mortgage instead.
The same applies for selecting a term. Someone who chooses a fixed-interest mortgage with a longer term may pay a higher interest rate than for a short term, but it is guaranteed for the stipulated term. Aside from the issue of security, the borrower's own expectations for interest-rate development should also be considered when choosing the term and the mortgage model. It may be advisable to consult with an expert early on for such decisions. An expert can give an objective outside perspective and keep sight of the bigger picture.