In-depth analysis of variable-rate mortgages: Features and how they work
A variable-rate mortgage loan is a type of loan with an interest rate made up of a fixed differential plus a reference rate (usually the Euribor). The amount of the monthly mortgage repayments increases or decreases depending on variations in the reference rate. The Euribor rate for the month in which the mortgage is signed is usually applied, and every six months the interest rate is adjusted based on the latest Euribor rate.
A mortgage is an agreement that conveys right of ownership on an asset as security for a loan. When applying for a loan at a bank, the bank may require the setting up of a mortgage. This, then, is a mortgage loan, usually referred to as a “mortgage”. The aim of a mortgage application is usually to finance the purchase of a house, with the property itself as the guarantee.
The borrower (who receives the money) commits, when signing the contract, to returning the amount lent plus the amount corresponding to interest, in monthly repayments and over a specific period of time. In all mortgage loans there is the personal guarantee of the borrowers and the guarantee of the property. This means that if the borrower does not keep up to date with the repayment of the debt, the credit institution may repossess the home.
Depending on the interest rate applied to the mortgage loan, there are three types of mortgages:
- Variable-rate mortgage.
- Fixed-rate mortgage.
- Mixed mortgage.
A variable-rate mortgage is that in which the amount of the monthly repayments varies, based on a reference rate (usually the Euribor). The interest rate applied to the mortgage consists of the Euribor rate plus a fixed differential. The interest rate is usually adjusted every six months by the bank, based on the latest Euribor rate. Thus, the amount of the monthly repayment will be the same for six months, after which time the monthly repayment is recalculated, with the possibility of it increasing or decreasing.
A fixed-rate mortgage applies the same interest rate throughout the life of the loan. The interest rate is not subject to any reference rate such as the Euribor, therefore the monthly mortgage repayment will always be the same amount throughout the life of the loan, regardless of whether market interest rates rise or fall.
Mixed-rate mortgages combine the features of fixed-rate and variable-rate mortgages. For example, during the first 10 years of the mortgage a fixed monthly payment is made, and during the rest of the term until its date of maturity a variable interest rate is applied which will change as a function of the Euribor, based on what was agreed in the contract.
The interest rate applied on a loan is usually expressed with the NIR and the APR.
NIR (Nominal Interest Rate): it is a fixed percentage that is applied to the amount lent and that determines the amount of the installments to be paid to the financial institution. For a variable-rate mortgage, the NIR will be the Euribor rate plus a fixed differential.
Variable APR (Annual Percentage Rate): interest rate that indicates the actual cost or yield of a financial product. The APR is calculated based on a standardized mathematical formula that takes into consideration the nominal interest rate of the operation, the frequency of payments (monthly, quarterly, etc.), the bank fees and some operation expenses. The APR serves to compare different mortgage offers among different banks.
-The interest rate is adjusted based on what was agreed in the contract (typically every six months) taking the most recent value of the Euribor into account.
- Each time the interest rate is adjusted, the monthly payment changes. When the Euribor rises, so does the amount of the mortgage repayment. When the Euribor falls, the mortgage repayments also fall.
- Variable-rate mortgages typically offer lower interest rates than fixed-rate mortgages.
- Usually, the maximum term within which the loan must be paid is longer for variable-rate mortgages than for fixed-rate mortgages.
- As the repayment term is longer for variable-rate mortgages, the monthly payments are usually smaller than with fixed-rate mortgages. If in later months the Euribor rises, the mortgage repayments for a variable-rate mortgage could end up higher in comparison with those established for a fixed-rate mortgage when first signed.
What is a variable mortgage?
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