Mortgages are one of the most common financial products. When a mortgage is arranged, the buyer of a property undertakes to pay back to the bank the amount borrowed through the payment of instalments and interest for a stipulated period of time.
But how is mortgage interest calculated? First of all, to answer this question we must point out that there are three types of mortgages based on the applicable interest rate: fixed, variable or mixed rate. The interest rate will depend on the type of mortgage arranged with the bank. The following sections focus on the calculation of interest rates for fixed and variable mortgages. The mixed mortgage combines an initial fixed-rate period with a second variable-rate period until the maturity of the loan.
When calculating the instalment to be paid back to the bank, this is divided into two parts: the part used to repay the loan and the part used to pay the interest. Here is how to calculate a mortgage instalment based on the type of mortgage you have chosen.
How to calculate the interest on a fixed mortgage?
In a fixed mortgage or fixed rate mortgage, the interest rate remains the same throughout the duration of the loan, regardless of what happens with the fluctuations of the interest rates in the market, as it is agreed beforehand. It is not linked to the value of the Euribor and is the best option for those who want to know how much they are going to pay in each monthly instalment. It is worth noting that the interest rates will be higher at the beginning and then they will decrease.
To work out the interest on a fixed mortgage you have to make a simple calculation: the amount pending repayment is multiplied by the interest rate and divided by twelve, which are the monthly payments corresponding to the calendar year.
How is the interest on a variable mortgage calculated?
The calculation of the interest on a variable mortgage depends on two components: the Euribor and the spread. The spread is a fixed percentage determined by the bank, an amount that is added to the Euribor. Therefore, the Euribor determines the monthly instalment to be paid. It is calculated in the same way as for the fixed mortgage, except that the interest rate will change depending on the Euribor.
As a general rule, the instalments are fixed for the first year or two, and then become variable through annual or biannual reviews. The interest to be paid will depend on the Euribor at the time of the review.
What is the amortisation schedule and early repayment?
The amortisation schedule is a table showing the progress of the repayment of the mortgage. The table shows all the details of the loan, such as the payment of the instalments, the interest payment, the amortisation time, etc. In this way, we can see how much the monthly instalment increases and what part of that instalment corresponds to interest. The following factors are reflected in the amortisation schedule:
- Interest rate. As seen above, this is the amount expressed as a percentage that the buyer has to repay to the bank in return for the loan received.
- Monthly instalments. This is the number of instalments into which the loan payment is divided and which, as a general rule, normally corresponds to the months of the calendar year, i.e. twelve monthly instalments.
- Monthly payment. It is the sum of the interest payment plus the amortised capital.
- Accrued interest. It is the interest charged on the money that the bank has lent to the buyer, and not on the repayment of the loan.
- Amortised capital. It is the amount that the buyer pays to the bank for the repayment of the loan.
- Principal to be repaid. It is the remaining amount to be repaid to the bank after deducting the monthly instalments that have already been paid.
The amortisation schedule allows you to monitor the evolution of the loan, which in turn allows you to plan ahead to determine if you can make an economic effort while the debt lasts and make early repayments.
Early repayments involve bringing forward part or all of the loan repayment. This operation entails a fee set by the financial institution to compensate for the interest that will not be earned. The fee varies depending on the amount to be repaid and usually ranges from 0 to 2 %.
In early repayment, you can choose between these two options:
- Reduce the term of the debt. The loan will be paid off earlier, and since the interest will be applied to a smaller principal, you will also pay less.
- Reduce the instalment. In this case, the repayment term of the mortgage will remain the same.
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