Introduction
Loans taken out by the individual can take several different forms, ranging from payday loans, personal loans or home equity loan.
So, mortgage loan allows the borrower to have the money needed to buy or build a property. Taken out for a given period (10 years, 15 years or 20 years, etc.), its specificity is the mortgage, that is to say that the property serves as security for the repayment of the loan. If borrowers do not respect their commitments, mortgage lenders can seize and sell the property.
I- The different types of mortgage rates
What is an interest rate?
The interest rate is the price of money, that is, what a borrower must pay to a lender to receive a certain amount of money. It is usually expressed as a percentage.
There are many types of interest rates, which can take the following forms :
1- Simple or compound interest rate
A- Simple interest rate
With simple interest, the borrower pays the lender the interest owed on the original principal, according to a pre-determined schedule. A bond is the prime example of this type of interest.
B- Compound interest rate
Whereas with compound interest, the issuer pays interest on both the principal and the interest from previous years. This is the case, for example, with high-interest savings accounts.
2- Nominal or real interest rate
A- Nominal interest rate
The nominal interest rate is the rate that is agreed and paid, whether it is the rate paid on a loan or the rate paid by the bank to a saver.
B- Real interest rate
The real interest rate takes into account inflation, that is, the increase in prices. This can be determined by deducting the inflation rate from the nominal interest rate to obtain the real cost of borrowing or the return on investment.
3- Fixed or variable interest rate
A- Fixed interest rate
We are talking about fixed rate mortgage, when the rate does not change and remains the same throughout the duration of the mortgage loan regardless of changes in money market rates.
This type of rate is requested for the following cases :
- The expectation that interest rates will rise;
- The certainty of the interest rate to be paid;
- The borrower’s budget does not allow for a significant increase in the amount of payments;
- Stable and predictable payment amounts.
B- Variable interest rate
Whereas for the variable-rate mortgage loan, the lender can change it, up or down, depending on the variations in the key rate. There is therefore a direct correlation between the key rate and the variable rate.
Thus, this type of rate offers several characteristics :
- Lower interest rates as long as the Central Bank does not raise its key rates;
- Possible savings, when interest rates fall, leading to a reduction in monthly payments, in the case of an adjustable repayment plan;
- Flexible early repayment.
Furthermore, we can distinguish between two types of variable interest rate mortgages :
a- Mortgage loan with variable interest rates and payments
In principle, the loan term remains fixed. So, when interest rates decrease, mortgage payments also decrease, and when interest rates increase, mortgage payments increase.
b- Variable interest rate mortgage with fixed payments
Regarding this type of loan, when :
- Interest rates decrease : the installments to be paid will remain the same, which results in faster repayment of the loan since a smaller portion of the payment is used to pay interest on the loan;
- Interest rates increase : the installments to be paid will remain the same, which results in a slower repayment of the loan, since a larger portion of the payment goes towards interest on the loan. This situation increases the term of the mortgage.
C- Capped interest rate
Also called protected variable interest rate, is a solution intermediate between the fixed interest rate and the variable interest rate.
Thus, the interest rate that the borrower must pay will fluctuate according to the market, but cannot exceed a predetermined threshold, allowing him to obtain the advantage of a variable interest rate, without however having the disadvantage of assuming too large fluctuations in rates, if necessary.
II – What are the factors that affect mortgage loan?
Real estate interest rates are determined by a complex set of economic, financial and political factors.
These elements can vary over time and directly affect the conditions under which borrowers access mortgage loan.
Moreover, the interest rate applied to the mortgage loan is influenced by several factors, among which we can mention :
1- The monetary policy of the central bank
The role of the Central Bank is essential in setting interest rates. The key rate set by the Central Bank directly influences the rates charged by commercial banks.
In fact, the key rate or central bank rate is the rate at which banks lend and borrow from the central bank.
Individuals are therefore affected by variations in the key rate. This is because it influences the interest rates on various types of loans, including mortgage rate, particularly variable rates.
In principle, the central bank adopts either an accommodating policy by keeping interest rates low to stimulate the economy, or a more restrictive policy by making interest rates high in order to make borrowing more expensive and slow down the economy in the event of high inflation.
2- Inflation
When inflation rises, the purchasing power of money decreases, prompting the central bank to raise its key interest rate to prevent the economy from overheating.
During times of high inflation, mortgage interest rates also rise, as lenders want to protect themselves against the loss of currency value over time.
Lenders must ensure that interest rates remain above the inflation rate to maintain the value of returns. As a result, mortgage rates tend to rise with inflation.
3- The health of the economy
The state of the economy as measured by indicators such as GDP, employment and consumption, both nationally and internationally, have a direct impact on the real estate interest rate.
Thus, the economic situation can have two different aspects :
A- Economic growth
A growing economy leads to increased demand for goods and services, including mortgages, which can push rates up.
B- Economic recession
In times of slowdown or economic recession, the Central Bank tends to lower the interest rate to stimulate the economy, which results in lower mortgage rates.
4- Supply and demand for credit
In general, interest rates are partly determined by the balance between supply and demand. This fluctuation in supply and demand can result in two possible scenarios :
A- Increase in demand
When many households want to take out mortgages, banks can raise rates to regulate this demand and guarantee their margins.
B- Reduction of demand
If demand for credit decreases, banks may offer lower rates to attract more customers. In times of economic uncertainty, for example, demand for credit may decline, leading to lower rates.
5-Credit risk assessment
Credit risk is the risk that a borrower will not repay their loan as expected.
In this context, banks adjust their interest rates according to the risk they consider they run by lending money.
Several factors come into play in assessing this risk :
A- Overall economic situation
In times of economic crisis or political uncertainty, banks may raise rates to compensate for the increased risk of borrower default.
B- Borrower profile
The more risky a borrower is considered, due to high debt or poor financial stability, the higher the rate applied to compensate for this risk. On the other hand, a solid borrower profile with a good credit history may benefit from more advantageous rates.
Compared to consumer loans, the risk incurred by the bank in granting a mortgage loan is limited since it has, as collateral, a property that can cover the repayment if necessary. This is why, in general, mortgage interest rates are lower than those of consumer loans.
6- The cost of refinancing banks
The lender’s refinancing cost is one of the factors that largely determines the mortgage interest rate.
In principle, banks themselves borrow funds on the financial markets in order to grant loans.
So, if conditions in the financial markets are unfavorable and banks have to pay more to refinance, they will pass these additional costs on to mortgage rates.
This is the case during strong economic growth, because when the economy is strong, more businesses seek funds from investors to finance their expansion.
Mortgage lenders must therefore offer higher interest rates to investors to encourage them to lend them funds rather than pass them on to another business.
7- Competition between banking establishments
The level of competition between banks also influences mortgage rates, this time downward.
Thus, in times of strong competition, banking establishments may be forced to lower their rates to attract more customers.
8- Information for borrowers and investors
Borrowers and investors are encouraged to actively monitor economic news and central bank announcements in order to adapt their strategies as developments occur.
Conclusion
Active debt management through debt consolidation loan is one of the essential strategies to adopt to properly control debt, especially if the individual takes out several debts at the same time, such as mortgage, credit cards, personal loans, etc.
Thus, a debt consolidation loan involves taking out a new loan to repay all existing debts, allowing the individual to have only one monthly payment, often with a lower interest rate than previous debts. This simplifies budget management, as there is only one creditor to repay.
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