Knowing all the concepts that make up a mortgage loan will be very useful to know which mortgage best suits our needs. Today, at Mortgage School , we will talk about the three fundamental elements that make up every mortgage loan . These are the capital , the term and the interest rate .
Broadly speaking, the capital (also called principal ) is the amount of the loan given by an entity through a mortgage loan to the client and which the latter agrees to repay in periodic installments within the amortization period (term in which the loan must be repaid) and with the interest rate agreed between both parties. The three elements will also determine the installment that will have to be paid.
What is interest rate and what are the rates available on the market?
The interest rate is the price we will pay to the Entity for the money it has lent us. It will directly influence the payment; the higher the interest rate, the higher the payment.
There are, in general terms, three types of mortgage loans that differ in the way the interest rate is applied. Thus, we can find fixed-rate mortgages, variable-rate mortgages and mixed -rate mortgages:
- Fixed interest rate: it remains constant and stable throughout the life of the loan , regardless of market fluctuations and oscillations. The great advantage is that it provides stability and peace of mind: the client knows the installment to be paid throughout the application period.
- Variable interest rate: as its name suggests, it varies over the life of the mortgage loan. It is calculated taking into account two factors: the reference rate (which varies with market fluctuations) and the spread (agreed with the bank). The most widely used reference rate today is the Euribor , which currently has minimum values. Its disadvantage is that it is subject to market fluctuations and can cause the instalments to increase or decrease considerably in the medium or long term.
- Mixed interest rate: combines the other two interest rates. At the beginning of the mortgage loan, a fixed rate is usually established (for a period of up to 15 years). After this period, the mortgage will have a variable interest rate and the instalment will fluctuate depending on the market situation.
How is the installment to be paid calculated and what types of installments exist in a mortgage loan?
The installment is the amount that the borrower of a loan pays periodically (usually monthly) to the creditor, until the amount borrowed plus the agreed interest is repaid. As we mentioned above, the installment to be paid will be calculated taking into account the borrowed capital, the agreed interest rate and the term of the loan. The higher the borrowed capital and the interest rate, the higher the installment. However, the longer the term, the lower the installment, although the amount allocated to the payment of interest will increase. There are different types of installments, but the most commonly used are:
- Fixed rate: This is the most common type of payment in Spain, following the so-called French amortisation model. In this type of payment, the client pays a constant amount of money during the fixed-rate period of their loan. Once the fixed-rate period has ended, the payment is calculated at each review, usually annually or half-yearly, based on the evolution of the reference index plus the agreed differential. This payment is made up of capital (payment amount intended to reduce the capital loaned) and interest (payment amount intended to pay the entity for the amount loaned).
During the first years of the loan, the interest portion is greater than the portion allocated to capital amortization , with this proportion changing as the years go by.
- Increasing or progressive installment: the client pays a lower installment at the beginning of the repayment period and this is increased by a certain percentage annually. Thus, during the first months or years of the mortgage, the installment will be lower compared to a constant installment, but it will increase year after year during the progressive installment period. Once the term with progressive installments has ended, the installments will be revised based on the outstanding capital, the remaining repayment period and the interest rate resulting from applying the reference index plus the differential agreed with the entity.