A mortgage loan consists of receiving a certain amount of money -capital- from a bank in exchange for the commitment to return said amount, plus the corresponding interest -based on the interest rate-, through the periodic payment of quotas that They are usually monthly. As a guarantee of payment, the property acquired is also offered. This is the definition of mortgage loan offered by the Bank of Spain and contains the three key elements to understand how a mortgage works: capital, interest and amortization period.
Key 1: the capital
It is the amount of money that we request from our bank when buying or renovating a home. As a general rule, the bank finances up to 80% of the appraisal value of the property if it is the first home and around 70% if it is the second. What happens to the remaining 20%? The customer must deliver it as a first payment or "entry" at the time of purchase of the home. This is so for two main reasons: on the one hand, that the client has 20% of the value of the property in advance demonstrates its ability to save, something that banks value; On the other hand, by financing up to 80% of the property, the bank does not assume all the risk of the operation in case of default by the buyer.
For example, if the home we want to buy costs € 100,000, the most usual thing is for the bank to finance us up to € 80,000. However, it should be noted that there are also mortgages at 100% financing of the value of the property. The banking entities offer them to those clients who demonstrate a very important solvency and economic stability, for which the risk of default that the bank runs is much lower. In this regard, owning a second home or the solvency of the guarantors supporting our request are important points when granting this type of financing.
The appraisal of the property can also be another way to access a mortgage loan at 100%. If, after assessing the property that we want to acquire, it turns out that its value is higher than the market price, the bank could facilitate its full financing.
Another additional way to get 100% financing is to acquire a home that the bank already has within its offer.
Key 2: interest
The interest is the economic benefit that the bank obtains by granting the client access to the requested financing. In the case of variable rate mortgages, it is composed of two parts: the reference index and the differential. The sum of the two offers us the time of interest we will pay for our mortgage.
- The reference indices. These indices are used to modify the interest rate of the variable rate mortgage loan, that is, they indicate how the price of money evolves and this affects the total amount that the client will have to repay in the monthly installments and, therefore, It influences the total to be repaid at the end of the life of the loan.
In Spain, the most commonly used reference index is the Euribor, which shows the price at which European banks lend money to each other. Its revision is usually annual, although it can also be done quarterly or semester. After this revision, the monthly fee to pay for the client can go up or down, depending on the evolution of the Euribor.
In addition, there are other reference indices, among which the Entity Set Index stands out.
- The applied differential. This is what the bank charges for assuming the risk of financing the purchase of a property.
With these factors in hand we can differentiate three types of mortgages depending on the interest rate that apply:
- Fixed rate: In order to calculate the cost of fixed rate mortgage loans, the Euribor is not taken into account, only the fixed interest rate applied by the bank, so you always know exactly the monthly payment that will be paid.
- Variable rate: In the case of variable rate mortgages, the most common is to have the Euribor as the reference index, which varies daily, although the most common is that the interest rate on the loan is updated every 6 months. the value of the Euribor at that time. In this way, the reference index determines the cost of the mortgage loan: the lower the Euribor, the lower the monthly mortgage payment for the client.
- Mixed rate: These mortgages apply a fixed rate during the first years of the loan, and then proceed to apply a variable interest with reference in the Euribor.
Two other important concepts that make reference to the price of a mortgage loan are the TIN and the TAE:
- The TIN is the acronym of Nominal Interest Rate: it is the price that the bank charges for lending money during a certain period of time. This figure does not take into account any additional expenses associated with the mortgage contract, such as an opening commission. It serves as an indicator of the price of that product or financial operation within the same bank, so it does not serve to compare product prices neither in the entity in which we request the loan nor among other entities.
The APR is the acronym of the Annual Equivalent Rate: it indicates the effective cost of a loan during a given period according to a standardized mathematical formula used by all banking entities, that is, it allows comparing the cost of the same product among banks. The TAE does include the cost of commissions and some expenses associated with the loan.
When a bank offers a variable rate mortgage loan it is usual to see its cost expressed in three different ways: through the TIN, the Variable APR and the applied Euribor + differential formula.
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Key 3: the amortization period
It is the time that we are going to take to return the capital that they have lent us plus interest. The most common in Spain is to find mortgages that offer a repayment period of 20 to 30 years, although there are also from 5 years and up to 40.
During this amortization period we will face a series of monthly installments whose amount will depend both on the time we have to repay the loan and the capital they have lent us and the interest that we have to pay. The longer the refund, the lower the fees, but the higher the interest we will pay at the end of the life of the mortgage, and vice versa.
Summing up, the monthly payment will be the sum of the interest plus the capital, but its composition, what is paid at each moment, will vary throughout the life of the variable mortgage, being the same in each installment of the mortgage at fixed.
The most common way to calculate what is paid in each installment is to use the so-called 'French method', by which at the beginning of the life of a mortgage loan the principal interest is amortized and, in a lower percentage, the capital. As time goes by, this proportion will be invested and, in the last installments, capital will be paid mostly.
