In the current economic climate, with interest rates rising after years of historic lows, mortgage prepayment has become a key financial strategy for thousands of Spanish households. Understanding what prepayment means, how to do it, and when it is most advantageous can lead to significant financial savings and provide greater financial peace of mind in the medium and long term.
Amortizing a mortgage means gradually paying off the debt owed to the financial institution by making the payments established in the contract. Each mortgage payment consists of two parts: the part corresponding to interest and the part that reduces the outstanding principal (amortization). Over time, as the principal is amortized, the interest is calculated on a smaller amount, which means that, in the most common amortization system (the French system), the proportion of the payment allocated to interest decreases while the proportion allocated to amortizing the principal increases.
In addition to this ordinary repayment through regular installments, there is also early repayment, which consists of returning an additional amount of money to the bank on top of the monthly installment, with the aim of reducing either the outstanding capital or the term of the mortgage.
This is the most common system. It is characterized by constant payments throughout the life of the loan. At the beginning, most of the payment is interest, and a smaller portion amortizes the principal. Over time, this ratio is reversed.
Advantages and disadvantages
It has constant and predictable installments, which facilitate financial planning, but since a lot of interest is paid at the beginning and little capital is amortized, the total cost of the loan is higher if no early repayments are made.
Example
For a 30-year loan of €200,000 with a fixed interest rate of 3%, the monthly payment would be approximately €843. In the first payment, about €500 would be interest and only €343 would repay the principal. After 15 years, the composition would have changed: about €300 would be interest and €543 would repay the principal.
In this system, the principal repayment is constant in each installment, but the interest is calculated on the outstanding principal, which decreases. This results in decreasing installments.
Advantages and disadvantages
The total cost in interest is lower than in the French system for the same term and interest rate, but the initial payments are very high.
Example
For the same 30-year loan of €200,000 at 3%, the constant monthly repayment would be €200,000 / 360 = €555.56. Added to this is the interest for the first month (€500), giving an initial payment of €1,055.56. At the end of the loan, the payment would be only €556.
Linked to investment products. The borrower pays only interest periodically during the term of the loan, and at maturity, must repay the total principal in a single payment (bullet), which is usually covered by a parallel savings or investment plan.
Advantages and disadvantages
The payments are lower during the term of the loan, as only interest is covered, but there is a high risk at the end of the term, as you must have all the capital available to pay off the debt.
Example
For a loan of €200,000 at 3%, the monthly payment would be only the interest: €500. At the same time, the customer sets up a savings plan to accumulate €200,000 over 30 years.
Amortization works based on the relationship between the outstanding principal, the interest rate, and the term. Each payment first satisfies the interest for the period, and the remainder is used to reduce the debt. This reduction means that, in the following period, the interest payable is slightly lower. This "snowball" effect is slow at first, but accelerates over time.
In an early repayment, the additional money contributed is deducted directly from the outstanding principal, causing a "jump" in this process, drastically reducing the calculation of future interest and lowering the monthly payment or shortening the term of the loan.
To calculate the constant quota in the French system, the following formula is used:
C = K * [ i * (1 + i)^n ] / [ (1 + i)^n - 1 ]
Where:
For a principal amount (K) of €150,000, an annual interest rate of 2.5% (monthly interest rate = 0.025/12 = 0.002083), and a term of 20 years (n=240 installments):
C = 150,000 * [0.002083 * (1.002083)²⁴⁰] / [(1.002083)²⁴⁰ - 1] ≈
€794 per month.
There is no single formula for calculating the savings from early repayment, as it depends on the option chosen. However, the calculation of the new outstanding principal is as follows:
New Principal = Outstanding Principal - Early Repayment
Let's assume that after five years of the mortgage in the previous example (€150,000 at 2.5% over 20 years), the outstanding principal is €120,000. If you make an early repayment of €20,000, the new principal will be €100,000.
By reducing the installment amount, with the remaining term, the new installment is recalculated based on €100,000, resulting in approximately €530 (compared to €794).
By reducing the term while maintaining the €794 installment, the time needed to repay €100,000 would be drastically reduced.
The easiest way to calculate these scenarios is by using the early repayment simulators offered by most banks on their websites (Bankinter, Banco Santander, Sabadell, etc.) and independent financial portals (Rankia, Idealista).
First, you should review your mortgage contract (you may be interested in: annual mortgage review). Check the conditions for early repayment, particularly the fees. You can also request a detailed simulation from your bank.
Then compare and decide, assessing whether you are more interested in reducing the installment to ease your monthly cash flow or reducing the term to save more interest and become a homeowner sooner.
Finally, formalize the transaction by signing the documentation that modifies the terms of your mortgage.
The profitability of amortization depends on the interest rate of your mortgage and the investment alternatives available.
With variable-rate or high-fixed-rate mortgages, amortization is generally very profitable, since the savings in interest are equivalent to obtaining an after-tax return equal to the mortgage interest rate.
En hipotecas a tipo fijo muy bajo (<2-2,5%), la rentabilidad relativa es menor. En estos casos, podría ser más beneficioso invertir ese dinero en productos financieros que potencialmente ofrezcan una rentabilidad superior.
In addition, it is more beneficial to pay off the loan at the beginning, when the portion of the payment that is interest is higher.
You might be interested in: fixed, variable or mixed mortgage.
Save on interest: reducing the outstanding capital decreases the total amount of interest payable, reduces the monthly or term payment, provides peace of mind by reducing the level of debt, and allows for greater future savings capacity.
There is a loss of liquidity, as well as an opportunity cost, since the money used for repayment could generate a higher return if invested in other products. There may also be fees if repayment is made before the legally established deadlines, and there is a risk that the tax authorities may consider the debt cancellation as capital gains.
In the current context of rising ECB rates, if you have a variable-rate mortgage, your Euribor + spread may be above 3.5% to 4%. In this scenario, paying off your mortgage is one of the best investments you can make.
Make sure you have enough savings to cover at least 3 to 6 months of expenses before allocating extra money to your mortgage.
Generally, reducing the term generates greater total interest savings, but reducing the installment offers more monthly flexibility. Choose based on your priority.
For very large repayments or total cancellations, it is advisable to check the possible tax implications.
Sometimes, institutions may offer you favorable terms or fee exemptions so as not to lose you as a customer.
There is no legal limit. You can repay anything from small amounts to the entire debt.
No. Early repayment does not have any direct tax benefits.
Mortgage repayment insurance is a product that covers your mortgage payments in the event of death, disability, or unemployment. The cost varies, but can range from approximately €200 to €600 per year.
Reducing the term is more cost-effective, as you save more interest by shortening the life of the loan. Reducing the payment is better if you are looking to improve your immediate monthly liquidity.
Perhaps nothing. By law, variable-rate mortgages have no commission after three years, and fixed-rate mortgages have no commission after ten years. If you repay early, the maximum commission is 0.15% for variable-rate mortgages and 2.5% for fixed-rate mortgages.
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Paying off your mortgage is a financial strategy that should be considered after careful analysis of the specific terms of each mortgage, your personal liquidity situation, and your long-term financial goals, but it may be the best option for your pocketbook and your peace of mind.
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Funded:
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Objective:
1.057.019,75 €
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