Hi ladies, we want to talk to you about mortgages. Yes, we know, not the most fun topic, but important, because it is often the longest loan you take out. And a question we often get about paying off your mortgage: how, what and where?
What is a mortgage?
In short, a loan you take out often for buying a house, with that house also serving as collateral. As the owner, you offer this piece of real estate as collateral and are thus the mortgagor. The bank or other organization can accept that including the collateral and provides the loan, which is the mortgagee.
So the terms are exactly the opposite of what you probably think. Anyway, so a loan, for a long term with agreements on repayment and interest.
What forms are there?
The three most well-known are; installment, annuity and linear. So we’re going to talk about that today, because for redemption, they all work a little differently.
Redemption-free
The name says it all, with this mortgage you don’t repay anything, you just pay the interest. This form has been popular for a long time, because you have fixed monthly costs “and,” the mortgage brokers told you, “the value of your home goes up anyway, so at the end when you sell it, you pay it all off in one go.
This became painfully obvious in 2008 when many homes became underwater. Their outstanding mortgage debt was higher than the value of the home. Since 2013, this form of mortgage has not been encouraged. If you had an installment-free mortgage before then, you may include it in refinancing a home.
Linear mortgage
This mortgage goes down in a straight line. Each month for this type of mortgage, you pay a bit of interest and repay. The repayment reduces the original amount, so you pay slightly less interest and need to repay slightly less over the remaining term. So a straight line down.
Annuity mortgage
This is a more complicated form. Your monthly amount remains the same for the term (provided the interest rate and term do not change) only the ratio of interest to principal changes.
Example; your monthly amount is € 900, of which € 250 is interest and € 650 is the amount you repay. That means that after that month, your debt is reduced by €650 and you pay less interest per month because the debt is smaller.
In month 2, you then pay € 900 per month again, but then it is € 248 interest and € 652 repayment. As with interest on interest, this works exponentially. So in the final throes of your mortgage, the bit of interest you still pay is minimal and you pay off almost the entire monthly amount.
Why redeem?
There are several reasons to pay off your home, and the choice is also entirely up to you whether or not to do so.
First of all, your monthly payments go down as you repay or your term gets shorter, whichever you choose. It makes sense, too, because you reduce the debt you have. The smaller the debt the less you have to pay or the less time.
Perhaps you have agreed on an interest rate fixed period and you are afraid that after that period you will have to pay a higher interest rate with associated monthly fees. If so, it may be convenient to repay so you have less risk with a higher mortgage.
It can also give a lot of peace of mind when you know you can always afford your home no matter what the circumstances. Or perhaps you want to bring down your fixed expenses for the future so you need less money for living expenses.
Ratio of market value to debt change.
Many mortgage lenders have a risk premium on the interest rate. That means that if the value of the house and the debt are close together, the mortgage lender finds that more exciting, than a higher market value than the debt. Then they know for sure that they can sell the collateral properly if obligations are not met.
They offset this risk against mortgage interest. For example, you might have an interest rate of 2.5% and 0.2% risk premium, making you pay 2.7%. To indicate how great the risk is, the mortgage lender uses a graduated scale. If the ratio of your home to market value is 90%, then you have the highest risk premium, if you manage to bring that down then the risk premium comes off.
Calculate ratio of market value and mortgage debt.
According to the real estate agent, the value of your home is €200,000 and you still have a mortgage debt of €180,000. Then the ratio is €180,000 / €200,000 = 90%.
So you can influence that relationship in two ways. Redemption or a new appraisal with a higher market value.
Increasing your market value
In this market, you naturally see homes in your area selling for high prices. Don’t plan to move, but still want to take advantage of this higher value. If so, ask your mortgage lender if you can submit a new market value. Some lenders accept the WOZ; others require an official appraisal report from a broker. You can deduct the cost of that appraisal report from your taxable income from the IRS. Furthermore, mortgage lenders often charge a fee for administration.
By the way, tax expert Christin Avetisian is giving a master class March 15 on how to properly file your income tax return. Something for you?
So it does take time and money to have the market value of your home increased. But can cause you to immediately start paying less per month when the risk premium disappears.
How do I calculate my repayment and the snowball effect?
You achieve a snowball effect with paying off your mortgage if you make additional monthly or annual payments and start paying off the amount you have to pay less monthly/yearly as well.
Example:
Your monthly amount is € 900 of which you will pay off € 650. You decide to make additional monthly repayments of €100. That means your monthly fee changes to €898 per month. You still repay € 650 by default and repay an additional € 100 + € 2 the following month. That two euros is the difference between €900 (old monthly amount) and €898 (new amount). That following month, the new monthly amount is €897, and you pay off €103 each month.
In the long run, this causes a snowball effect as you pay off interest on interest.
For your annuity mortgage, this principle also applies, but the repayment/interest ratio proceeds slightly differently.
To make it easy, we have developed a tool especially for members that allows you to see for yourself how your mortgage repayment is going. Not a member yet? Join soon!
