How Mortgages Work
I have this silly habit of wanting to better understand things that affect me. These last few months I've been working on a calculator for monthly mortgage payments. Or in short, which has better SEO:
I've had a mortgage for a year and a half and it's quite a world. When I started looking for banks and asking friends, you realize there are many myths and beliefs. The ones that surprised me the most were:
The "variablelivers"
At the time I took out my mortgage, interest rates were rock bottom and had been for years. You could get fixed-rate mortgages at just over 1% interest. Yet still, many friends recommended variable rates. The variable-rate enthusiasts had their mantra: "The Euribor won't go up!" How quickly things got complicated for them...
Historical Euribor values
|Year| Value| |2022| 3.018%| |2021| -0.487%| |2020| -0.481%| |2019| -0.272%| |2018| -0.147%| |2017| -0.189%|
Always Pay Extra!
Another very common species has a commandment they preach: "As soon as you save something, pay extra!" "You have to get rid of the loan as soon as possible!" Well, not always. And my own case serves as an example. My mortgage is 1.6% fixed rate. As I write these lines, there are deposits at 2%. I earn ~0.4% annually without risk. Should I pay extra? Really? Then there's inflation - everything will be more expensive in 30 years, I'll also earn more (hopefully), but what about the monthly payment? It will be the same. In the end, paying extra is simple: if you have money just sitting idle in your account, pay extra. If you can get better returns than your mortgage interest, don't pay extra.
Those with ultra-low rates. Master negotiators.
Finally, I also met some who had very, very low rates, and I was surprised - how did they manage that? When you scratch the surface a bit, you discover the truth. They had contracted everything with the bank, even the house alarm! Home insurance, alarm system, life insurance, payment protection insurance - who offers more? And all these insurances included in the total debt, earning their good interest on them too. The real monthly cost of the mortgage was very different from just accounting for the interest rate. I'll talk about that later but spoiler: the insurance policies offered by banks are more expensive and worse (combo deal).
Whatever the case, if what I'm telling you sounds like Greek to you, stick around and I'll try to resolve your doubts. Open the Mortgage Calculator in another browser tab and start playing around.
French Loan System 🇫🇷
Mortgages in Spain use the French loan system. The nice thing about this type of loan is that the payments are the same throughout the life of the loan, which helps avoid unexpected changes, etc. This has made them the most common. This brings me to another widespread myth: "In mortgages, you pay much more interest at the beginning than at the end" and well, while it's true that you pay more, the only reason is because you owe more! If the payment is always the same and at the beginning you owe the bank EVERYTHING, it's normal to pay more interest. Let's look at an example to understand it better.
Imagine a loan of 100,000 for 10 years, with a 1% interest rate. Round numbers to make calculations easier. The interest is annual, so the first year you have to pay the bank 1% of 100,000€. That's 1,000€. Divided by 12 months, 83.3€ monthly. The rest of the payment is the debt that you're reducing, in this case 876.04€ - 83.3€ = 792.74€ monthly. 9,512.88€ annually.
Now let's go to year two. The debt is now the result of subtracting what was paid in the first year from the initial debt, that is 100,000€ - 9,512.88€ = 90,487.12€. The second year's interest is then 1% of this figure, which is 904.87€. Only 75.41€ each month. It has decreased by about 8 euros compared to the previous year (83.3€). Can you see the trend? Each year you pay less interest because you're reducing your debt.
The Down Payment
As a general rule, the bank will give you a mortgage for a maximum of 80% of the property's value. This value is obtained through appraisal. If the sale price is lower than the appraisal value, that price will be used. Always the minimum of these values (sale or appraisal). Moreover, the 80% is given if it's your first home, where you'll be registered as a resident. For a second home, the maximum mortgage value is 70%.
Fixed, Variable, or Mixed Rate
When you take out a mortgage, you can choose fixed or variable rate (mixed is a combination of both). Fixed rate, as the name suggests, is decided at the beginning of the loan and doesn't change anymore. It can only change if you have bonuses for having your salary paid into the account, etc., and you stop meeting these conditions.
Variable rate depends on the famous Euribor. I won't go into detail about what the Euribor is, but think of it as a reference index that can go up or down, and your mortgage interest will depend on it. For example, imagine you have a mortgage where your interest is "Euribor + 0.5%". Well, if the Euribor is at 3%, your annual interest will be 3.5%. Usually, the interest is recalculated every 6 months or annually.
The million-dollar question, which is better? The answer depends on the general economic context and your particular case. No one knows in advance which will be better, so it comes down to choosing between the risk of variable or the peace of mind of fixed. Also, remember that you can change your mortgage to another bank during the loan term. Imagine you take out a mortgage at a high fixed rate and then the Euribor drops significantly. Banks will start offering mortgages with better conditions than yours, and you can switch. It's called refinancing. It's also likely that if you show your bank you're planning to leave, they'll improve your conditions.
Property Purchase Taxes - VAT or Transfer Tax
Two things are certain in life: death and taxes. Did you think you wouldn't pay taxes for buying a property? Of course you do, and not a small amount. If the property is new, it's simple - it's 10% VAT. If it's a resale property, things get more complicated. Like with income tax, each region does as it pleases, and Madrid wins again with just 5%. I show a comparison by region and the taxes for all regions in a tab of the calculator.
Notary and Other Expenses
Finally, there are notary fees, real estate agency fees if you use one, etc. It's very difficult to estimate because it depends a lot on the case. In the calculator, I've put 0.5%, but it can vary greatly depending on the property value.
Health, Life, and Extra Insurance - Compare Well
So far we've seen the mandatory expenses. But the bank always wants more. Since they earn so "little" from the mortgage, they try to sell you various insurance policies. These insurances give you bonuses and lower your interest rate. You need to do the math, don't rush and calculate if it's worth it. In most cases, it's better to contract insurance (if you need it) on your own. The only mandatory insurance is home insurance, nothing else. In my case, they forced me to contract home insurance with them for the first year. The following year I cancelled it and got better insurance with over 100 euros in savings. Repeat after me: mortgages from banks, insurance from insurers.
What I'm sure is never worth it is including the cost of all years' insurance policies within the mortgage loan. You'll pay unnecessary interest. To make calculations easier, I've included this section in the calculator where you can see how these extra insurance policies affect the monthly payment.
Early Repayment
Early repayment means advancing payment of your debt to reduce it. There are two types of repayment. One option reduces the loan term (fewer months) and the other option reduces the monthly payment. The option that saves more interest is reducing the loan term, but it's a matter of preference. Maybe it's better to reduce a very high payment that's strangling us. In the Mortgage Calculator you can compare both options.
Conclusion
This concludes this brief introduction to mortgages. It's possibly the most important loan a person takes out in their life, so it's worth understanding it well.