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Even when you understand how mortgages work (start here if you dont), many of the nuances can be overwhelming. Especially if you suddenly find yourself making decisions in the midst of a fast-moving home-buying process. Read on to understand the background to some of the choices you may have to make…
The Interest Rate is VERY Important
The interest rate is the ‘cost’ of the mortgage, so you obviously want the lowest rate. It’s hard to overemphasise just how important it is, because of how mortgage maths works. At 3.5%, a €250k mortgage over 30 years will cost you €154k in interest - you’ll re-pay €404k in total. But with an interest rate just one percent lower, at 2.5%, the same mortgage will only cost you €106k. That 1% reduction will save you €48,000!
People are often surprised and shocked at how much interest they’ll pay. It depends on the interest rate (obviously!) but also on the term - a longer mortgage means more interest. The knock-on impact of this is that early repayments can make a huge difference, if you can afford them. We will delve deeper on interest rates in a future post (how and why they change, how interest accrues, and just how beneficial early payments are), but for now just remember how important interest rates are.
Money-Back Offers
These offers (2% back in cash, or €1,500 towards fees etc.) are designed to appeal at a time when you’ve probably emptied your savings to fund a deposit. But they almost always have higher interest rates, so much so that the higher monthly repayments will quickly eat into the up-front cash. For example, even a whopping €5,000 of cash-back on the €250k mortgage at 3.5% referred to above would be eaten up after a mere 36 months if it had a 0.4% higher interest rate. In other words, you’re worse off with the cash-back ofter from month 37 onwards. Always remember that if something sounds too good to be true (i.e. “free money”), it probably is, and you can be damn sure you are paying for it somewhere else.
Fixed or Variable
You’ll have to decide whether to ‘fix’ your interest rate for a period of time, or leave it variable. Fixing brings certainty, so you know for sure what your repayments will be for the next 2/3/5 or even 10 years. But fixed rates are often (not always, but usually) more expensive, so you’ll pay more for that certainty. On the other hand, a variable rate may be slightly cheaper now, with the prospect of even lower monthly payments if interest rates go down in the future, but a risk of higher payments if interest rates go up.
Variable rates offer more flexibility to repay quicker (or with a lump sum), in a way that can sometimes (but not always) be restricted with fixed rates. In some ways, deciding between fixed and variable is gambling on whether interest rates will rise or fall in the future. This is entirely unknowable, but our upcoming post on interest rate will explain a few perspectives on how to think about it.
Break Fees - Be Aware
If you fix your rate, you are effectively agreeing to pay the bank a fixed monthly payment for a certain length of time. The bank then arranges a complex transaction in the background where they also agree to pay a fixed (but lower) amount to the folks who give them the money to lend to you. The difference between those amounts is called the spread, and is essentially the margin the bank has to pay all its expenses (staff, IT, offices) and keep a profit.
If you want to alter the fixed payment schedule later (paying it back a bit quicker, or re-financing to a better rate) the bank will still be on-the-hook for the payments they have agreed to. They will charge you a fee to make up the difference, often referred to as a break fee. It’s complex to calculate and varies depending on how interest rates have moved since you signed the mortgage (amongst other things), but it’s important to be aware that it exists. It can come as quite a shock otherwise.
Early Repayments (even just a little ) make a HUGE Difference
Maybe you can afford to repay an extra €100 per month, or a 13th repayment every year, or a lump sum repayment if you get a bonus. Either way, an accelerated repayment can dramatically reduce the length of your mortgage and how much interest you’ll pay. Remember the first example in (1) above - if that person repaid an extra €100 per month they would knock 4 years off the mortgage and save €23,000 in interest!
Some practical tips:
Before choosing a fixed rate, check if the bank allows early repayment options - some do and they can be really useful.
You could also borrow over, say, a 30 year term but make repayments based on a 25 year term to finish early while still allowing yourself the flexibility to reduce your payments slightly if you ever needed to.
Or you could divide your mortgage into two separate loans - fix 75% of the amount and leave 25% variable to allow for early repayment.
Don’t Forget the Other Costs
It’s easy to stretch to your financial limits when buying a home, but don’t forget some of the other costs you’ll need to cover. Once-off costs include a valuation (€100-€200), survey (€250-€500), solicitors (€1,000-€2,500), stamp duty (1% of property value, potentially €2,000-€4,000+) as well as any costs of moving, new furniture or basic renovations. On an annual recurring basis, you’ll also have to pay property tax (€200-€500), home and contents insurance (€200-€500), electricity and gas/oil (€1,000-€2,500+), refuse collection (€300-€600), maybe a TV license (€200), and possibly even management fees to a management company (€1,500-€3,000).
These can add up quickly and it’s easy to overlook them in the heat of the moment and struggle afterwards. No wonder the cash-back mortgage offers can seem enticing!
Buying a home is stressful, but exciting. It’s easy to get overwhelmed with some of the choices and decisions you need to make, but it’s important to keep your head screwed on. It’s always wise to ask as many questions as you can think of, and many people find a mortgage broker or financial advisor can help too.
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