Reduce mortgage payment or shorten the term? Depends on how you make ends meet

The Euribor continues to rise. Last Monday it was above 3.5% and everything indicates that it will close February around these levels. The unstoppable bullish climb of the indicator has caused a significant shock to the economies of hundreds of families who have seen their mortgage payments skyrocket overnight. And not only that, but, paradoxically, this strong increase in the quota is not translating into a significant debt repayment.

The average increase in the amount of the fee exceeds 30% compared to a year ago, however, the fact of paying much more for the fee It does not mean that we repay more mortgage amounta, but quite the opposite, they warn from the Negotiating Agency. Besides, what is paid for interest takes most of the increase in the fee. In other words, the increase in the Euribor translates into an increase in the monthly payment, but in a correlative decrease in the amount that is amortized in said payment.

The increase in the Euribor has triggered the monthly payment, but this does not mean that more of the mortgage amount is amortized

An apparently atypical situation, but normal when interest rates rise. Taken to specific figures, according to the calculations made by the Negotiating Agency, for a typical variable mortgage of 150,000 euros, 20 years with Euribor + 2 points, in the last 12 months, the monthly fee has increased by 39.5%, 34% less capital is repaidgiven that the amount dedicated to interest payments is more than triplegoing from 206 to 676 euros in the installment for the month of February 2023.

“I’ve never registered before an increase of more than 200% in the interests of the installment in just one year”, highlights Luis Javaloyes, CEO of Negotiating Agency. “This is due to the credit amortization system, called ‘French system’, whereby the ratio between capital and interest in the installment varies as payments progress. So, At the beginning of the loan, more interest is paid than capital, while in the end practically the entire installment corresponds to amortization. And it implies that, since the number of months of amortization is predetermined, the increases in the installments are transferred to a higher interest payment but a much lower one
capital amortization”.

A scenario, hitherto unusual, that is taking some families —those who have some savings— to consider make an extra payment and repay part of the loan early. Is it a good time? Is it necessary to repay both if the mortgage is fixed or variable? What is better, pay off installment or term?

Is it a good time to pay off?

In the first place, and broadly speaking and attending to logic, the higher the Euriborit is more profitable to repay a variable mortgage, since the interests that we pay to the bank are higher, especially during the first years of the life of the mortgage. “It is always better to redeem when the Euribor is high because our money, at that moment, is worth more. Therefore, now we could say that it is a perfect moment to repay”, points out Simone Colombelli, director of Mortgages of the comparator and mortgage adviser iAhorro.

And to see it, he gives several real examples:

1.- Amortize in February 2022 a variable mortgage of 150,000 euros at 30 years with Euribor + 0.99%.

According to iAhorro’s calculations, if in February 2022 this mortgagee had decided to partially repay a mortgage of 150,000 euros with a term of 30 years and a differential of 0.99% + Euribor, that month the reference index for variable mortgages would be stood at -0.335% and, therefore, the interest rate you were paying on your mortgage at that time would be 0.66%. For this reason, the money saved by paying off the mortgage then would be much less than what would be saved now.

Thus, for example, if the fifth year of the mortgage was completed in February 2022 and the mortgagee had 10,000 euros to repay, could reduce the fee or term of the loan. In case of reducing quota, this would stay at 423.98 euros or, what is the same, you would pay some 35 euros less than what I was paying at that time unamortized: 459,06 euros. In this case, throughout the life of the mortgage, the total interest savings would be 872.61 euros, according to iAhirro’s calculations. However, if this mortgagee decides to amortize the term, that is,pay the mortgage in fewer yearsyour quota would continue to be 459.06 euros, but the savings would increase up to 1,763.69 euros because he would settle his debt with the bank two years and one month before after the 30-year term for total amortization has expired.

2.- Variable mortgage of 150,000 euros at 30 years signed in February 2023 with Euribor + 0.99%

Currently, the Euribor is close to standing at 3.5% (as of February 17, 2023, the average for the month is 3.467%). If we take that 3.5% to make the calculations for a 30-year mortgage of 150,000 euros with a differential of 0.99 and a Euribor of 3.5% (4.49% TIN) we see that the monthly fee will be 759.14 euros.

If this month of February 2023 the fifth year of the mortgage was fulfilled and the mortgagee had 10,000 euros to repayin case of reducing the fee, it would remain at 704.58 euros or, what is the same, it would pay 54.56 euros less each month. This would save 6,913.13 euros of total interest on the loan. However, if you decide to repay to reduce the term, that is, to pay the mortgage in fewer years, we see that in this same case Your quota would remain the same, but the savings would increase to 19,620.27 euros because, instead of stopping paying the mortgage in 30 years, they would do so in 26 years and 9 months.

At what point in the loan is it better to repay?

Second, one must take into account at what point in the mortgage loan is. At the beginning is when more interest is paid, so it is very interesting amortize as much as possible in the first years of the life of the mortgage. A little over a year ago, with the Euribor in negative, having savings it was more interesting to invest in other assets that give more profitability. “If instead of repaying in the fifth year of the mortgage you do it in the second, the savings will be much greater,” says Simone Colombelli.

“With the same previous example”, continues this expert, “if in February 2023 two years had passed since the loan was contracted and the mortgaged party had the same 10,000 euros to repay, the fee reduction would be a little lesssince this would remain at 707.55 euros, but 7,848.55 euros would be saved in interest. In the event that your intention was to amortize the term, your savings would be greater: would pay 23,548.39 euros less interest on the entire loan and the time of the mortgage would be reduced by 3 years and 8 months”.

Experts recommend amortizing in the first years of the life of the mortgage

Instead, if the 10,000 euros are amortized when it has already been paid half of the mortgage, the savings will be much smaller. “If it is decided to amortize the installment at 15 years of the loan, despite the fact that what you would pay each month would drop to 685.50 euros, the interest savings on the entire loan would be much less: only 3,990.18 euros. In case of choosing the term amortization option, you could save 9,412.05 euros in interest and stop paying the mortgage two years and a month before,” adds the manager of iAhorro.

However, at times like the present, another series of factors come into play. “The amortization in uncertain times is often a recurring idea for all those with a mortgage loan still in force,” says César Betanco, Hipoo’s mortgage expert. “Amortize part of the mortgage in installments or term It is already part of the usual concerns of the mortgaged in a context in which the Euribor seems to give no respite. But, is it profitable to pay off a mortgage right now?” asks this expert.

You must take into account the date on which the mortgage was signed and the Euribor at that time

Like Colombelli, for this expert, one of the key aspects to take into account before making a decision is the date on which the mortgage was signed and the Euribor data at that time. “If, for example, a mortgage with a fixed rate of 1% would have been signed a few years ago, it would not be worth it at all to partially repay the loan now. The best option in this case would be make profitable that signed interest and take advantage of having obtained a magnificent differential thanks to the low Euribor that existed at that time”.

In the same way, regarding the moment of signing the loan, he points out that, if the mortgage was formalized before January 1, 2013Yes, it would be convenient to repay early in order to be able to take advantage of the right to deduction in the annual income statement.

The decision seems complex, according to the Hipoo expert who also refers to the personal circumstances of each mortgagee. “To venture to raise to norm a situation of a private or individual nature It could lead to negative consequences depending on the mortgage and the profile of the contracting party”, he assures.

Better to amortize a fixed or variable mortgage?

Another aspect to take into account is if we are facing a fixed or variable mortgage. In this regard, Betanco is clear. “Right now, and with a Euribor at 3.4%, The best option in case you want to partially repay a mortgage is to opt for those that are signed at a variable rate.

In your opinion, due to the volatility of the Euriborbet on a partial or total amortization of a variable loan can be attractive given that during the next few months there will be numerous upward mortgage revisions.

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By contrast, for fixed mortgages, the Hipoo expert states that “unless a mortgage was signed with a Euribor higher than the current one, whoever had savings to repay their loan or part of it could allocate them to another type of investment”. And it ensures that the possible profitability obtained from this operation would be minimal or even nil.

Amortize installment or term?

Another question to decide is if you want to amortize fee or term. Do we want to pay less fee each month or the same fee but for fewer years? In the first case, the mortgagee can reduce your monthly payment while saving interestwhile in the second, it will reduce months to your loan so that you will finish paying your mortgage in less time.

When choosing, experts recommend amortize term due to the interest savings that it entails. And they assure that it is advisable to do so in the first years of life of the credit so that the savings are greater. This is so because of the amortization system used in Spain, the aforementioned ‘French system’, which consists of paying more interest than debt in the first years of the loan.

“If the mortgaged party has a good ability to pay, it would be best to repay the term”

“This is one of the biggest questions that often have the mortgaged when they contact Hipoo about these assumptions”, says Betanco. The dilemma is complex, in his opinion, although this expert limits both options. “If he mortgaged has a good ability to pay, then the best thing would be to amortize term. On the other hand, if you did not have sufficient financial slack and It would be difficult for you to make ends meet, the appropriate thing to do would be to repay the installmentin order to alleviate the monthly economic burden”.

“The best thing in these cases is usually to amortize the term because, by doing so, are removed interests shortening the life of the loan. In other words, a certain period of time is liquidated and this time is helped so that it does not generate more interest,” concludes the Hipoo expert.