The fixed-rate mortgage is considered by most, perhaps not without reason, the simplest formula for the consumer, and is associated with the certainty of having a constant installment over time and, consequently, no surprise, for better or for worse.
All this is obviously acceptable, however it is always good to understand in detail the mechanisms that regulate this type of loan and the main differences with respect to other formulas, in particular the variable rate mortgage
How the fixed-rate mortgage works
As we know, the fixed-rate mortgage has the characteristic of having an interest rate applied which remains constant for the entire duration of the loan. The consequence of this is that even the installment (usually monthly) that must be paid to the bank is constant over time.
The value of the interest rate is defined before the subscription of the loan and is generally given by two components:
- The Eurirs , an indicator whose meaning is quite complex: in practice it reflects the cost that the banks must bear to cover, through the purchase of derivatives, the risk of rising interest rates. Its value is a European average defined daily and varies according to the duration: in fact there are different versions of the Eurirs , at 5, 10, 15, 20, 25 and 30 years and in general the value increases with the reference time horizon . In fact, for a longer period of time, a higher cost will be incurred which the bank will have to bear to guarantee the aforementioned caution
- The spread applied by the bank, a value that may depend on the policies of each bank: low spread values in the phases in which it is desired to acquire customers, higher in the absence of strategies that have this purpose
Also read: What is the Eurirs and how to make predictions about its performance.
A practical example
Suppose you want to open a fixed rate mortgage with the following characteristics:
- Amount € 100,000
- Duration 20 years
- Fixed rate
Let’s assume that the 20-year Eurirs rate is 2.1% and that the spread applied by the bank is 1.3%. The rate applied will be 3.4%
2.1% ( Eurirs 20 years ) + 1.3% (spread) = 3.4%
Consequently our installment will be around 570 euros and this will remain for the entire duration of the loan.
Forecasts for fixed-rate mortgages
The question that could be asked at this point is the following: what is the use of knowing in detail how the interest rate is composed and how Eurirs works ? In the end things seem very simple: just know the amount of the installment and choose the lowest possible among the various proposals of the credit institutions.
This reasoning would be valid if we had already signed a fixed-rate mortgage , or if we had decided a priori that our choice would surely fall on a fixed-rate mortgage and whether the subscription date did not depend on us.
In other cases, on the other hand, it might be very important to have an idea of the current market situation and of possible evolutions.
Also in this case an example can help:
Let us assume that we are at a particularly favorable time for mortgages, and have found a very advantageous proposal for our 100,000 euro mortgage over 20 years:
1.4% ( Eurirs 20 years ) + 1.0% (spread) = 2.4%
Our monthly payment would be around 520 euros
Let’s now assume that we have to postpone for some reason the opening of our one-year mortgage and that in the meantime the 20-year Eurirs has increased by 0.4 points. The rate will become:
1.8% ( Eurirs 20 years ) + 1.0% (spread) = 2.8%
With a 2.8% interest applied, the installment would become around 540 euros, an increase of 3.8%. It should be noted that the difference of about 20 euros, multiplied by the 240 installments we are going to pay, would lead us to pay higher interest for 4,800 euros over time.
In practice, therefore, the forecasts on the trend of rates, and of the Eurirs indicator in particular, can be very useful for deciding, when one has the possibility, what is the best time to open a fixed rate mortgage or, more generally , to fine-tune its mortgage strategy. Think for example of the case in which you want to switch from a variable rate mortgage to a fixed rate, using the subrogation tool: choosing the best time, with low rates if not at the minimum, would be ideal to achieve a significant saving.
Comparison with the variable rate
The fixed-rate mortgage allows the borrower to sleep “peacefully”: any sudden changes in the reference context with associated indiscriminate rate increases have no effect on the fixed-rate mortgage. However, it must also be considered that, in particularly favorable periods for credit, with significant lowering of rates, those who have signed a fixed-rate mortgage cannot avail themselves of the benefits, as is the case for those who have a variable-rate mortgage.
We must also consider that the security of having a constant rate has a cost: the initial rate of a variable rate mortgage is generally lower than that of the fixed rate, sometimes even significantly. This range could be reduced, up to change of sign, if the rates should increase. On the other hand, it could expand further, in the event of a reduction in rates. Or, since a mortgage can last up to 30 years, both things could occur over time.