Monthly payments and interest rates

Why are these factors not the only thing to worry about in your mortgage?
In my work, I encounter a number of people with very different backgrounds. They normally have one thing in common though: they are looking for a mortgage in Spain. In addition, 95% of the times they have another thing in common: they are 100% focused on the mortgage interest rates we have access to and the monthly payments that they can expect in their mortgage.

These factors are obviously important when looking at a mortgage and this article is not meant to remove the focus from a good interest rate and a monthly payment that you are happy with. I will, however, try to explain why these numbers need to be studied in a context before one can celebrate a great mortgage deal and the victory over the bank who was blind enough to provide you with this superior mortgage offer.

In the world of mortgages you can rely on the same expression that I personally believe is a good guideline to how the world works: If it sounds too good to be true, it probably is.

So what is the issue then?
The issue with focusing exclusively on the rate (and the monthly payments), is that the best ones come with a cost. In Spanish, they call them “vinculaciones” which you could translate to “entailments”, “attachments” or simply “strings attached” in English. It means that the rates the banks present to you are normally subject to a series of conditions (contracting of certain products) and if you decline their kind offer of these products (at any time throughout your mortgage), your rate will go up with as much as 1% in total.

Generally, once you have reached a certain stage, the banks will explain that the rates you have been presented depends on you contracting e.g. their life insurance (0.1%-0.25% discount), their house insurance (0.1%-0.2% discount), their credit cards (0.1% discount), their pension plans/investment funds (0.1%-0.2% discount) and often they also “ask” you to deposit your salary into your bank account with them (0.4% discount). All in all, these products will provide you with a discount of up to 1%, so, although the actual rate of the mortgage is 3.25%, it will be presented as a rate of 2.25%.

Well, what is the issue then? Cut to the chase!
Well, the issue in my view is twofold. First, I find it problematic from an ethical point of view that the banks work their way around the truth as they see fit but at the end of the day, I suppose that isn’t of much news value, really. Secondly, and this is the important bit as it affects you as a client directly (and not just your sense or ethics): the products you contract to get your discount will cost you more than the discount they generate and still be expensive products.

Now you may very well think: “alright, but I do actually get a series of products for the price, so I suppose that’s okay then?”. But again I will insist that the answer is “NO”. The reason being that the products of the banks, e.g. the insurances, are often up to 3 times as expensive as what they would cost you from an external provider. So, not only are they falsely selling you a “low rate” but they are selling it to you with overpriced products to go with it. This means that very often you are better off taking a higher rate but not accepting the expensive products from the banks. You can then contract these products externally if you wish and still save money compared to the package from the bank including interest rate discounts.

Dinosaur crackers…
To simplify the issue at hand, you can compare it to when you are at the supermarket and you see a big package of dinosaur crackers for the kids and it says “family purchase – special discount” (or whatever it might say). The price on the big package is 5€ for 500g and it is displayed with a big sign to capture your attention. Next to the big package and one shelf below, you have the standard sized package (250g) with half the crackers for 2.39€.

Initially, the big package may very well seem attractive as it looks big and it says “discount” in red with LED lights! In addition, it is a universal truth that if you buy big amounts (of anything, really) you get a better price/kilo than if you buy less amount. In other words, you may not really start to look into detail, as you trust that the family package makes more economic sense than the standard package.

Nevertheless, as a very quick calculation will reveal, the best deal looking at price/kilo is actually the smaller package. The classic dinosaur crackers (which I personally hold very dear) in the standard package has a cost of 9.56€/kilo whereas the “family purchase – special discount” package has a cost of 10€/kilo. You save 4 cents/kilo by buying the smaller package although the initial impression was that you would be saving money by purchasing the bigger package.

If we now take the dinosaur crackers and put into a mortgage context, the important detail is that 4 cents may not seem like a significant difference but if you add a couple of zeros and were dealing with 95,600€ as opposed to 100,000€ it is easy to make a decision on which amount you would rather pay interests on, isn’t it?

The conclusion to all of this is that it is wrong to only focus on the interest rate and the monthly payments. It is wrong as the interest rate is not necessarily reflective of the real cost of the “package”. And the “package” costs money although the banks prefer to change the subject when this fact is addressed with them.

The same goes for the monthly payment, as this is very dependent on the duration of your mortgage (apart from the rate, of course). This means that a low monthly payment is not equal to a good mortgage. It is merely a function of the duration in addition to what interest rate you are paying. In fact, for capital repayment mortgages (which is what is available in Spain at the moment) the correct way of looking at it is the following: the shorter duration, the higher monthly payment but the less interests you end up paying by the end of the term. So more often than not, a high monthly payment will actually save you money compared to a lower monthly payment (longer duration).

Should you have any questions to this article, please do not hesitate to contact us at Spectrum International Mortgages.

We are always happy to assist with anything mortgage related in Spain.