A mortgage interest rate is influenced by several factors, both at the macroeconomic level and at the individual applicant’s level. Let’s look at them first in general and then in detail:

Macroeconomic Factors

• Cost of money: The European Central Bank (ECB) interest rate is the main benchmark for mortgage interest rates. When the ECB raises rates, mortgage rates also tend to rise.
• Inflation: Inflation erodes the value of money over time. To protect themselves from inflation, banks tend to increase mortgage interest rates.
• General economic conditions: Economic growth, political stability, and consumer confidence can influence interest rates. In times of economic uncertainty, rates may increase.

Mortgage- and Applicant-Specific Factors

• Rate type: Fixed-rate mortgages have an interest rate that remains constant for the entire loan term, while adjustable-rate mortgages are tied to a benchmark index (like the Euribor) and can change over time.
• Loan term: In general, mortgages with longer terms have higher interest rates.
• Loan amount (Loan-to-Value, LTV): The higher the loan amount relative to the property’s value (LTV), the greater the risk for the bank, and therefore the higher the interest rate will be.
• Applicant’s profile: The applicant’s credit history, income, and job stability are important factors for the bank in assessing risk and determining the interest rate. A higher-risk profile will result in a higher interest rate.
• Bank’s spread: The spread is the profit margin that the bank adds to the benchmark rate to cover its costs and generate a profit. Each bank has its own spread, which can vary based on its business policies.

Cost of Money

In economics, the cost of money represents the price you have to pay to use someone else’s money. In other words, it’s the interest applied to a loan or financing.

How is the cost of money determined?

The cost of money is determined by several factors, including:

• Benchmark interest rate: The benchmark interest rate is the rate set by the central bank (in the case of the eurozone, the European Central Bank) for the loans it provides to commercial banks. This rate directly influences the interest rates that banks apply to their customers.
• Bank spread: The spread is the profit margin that the bank adds to the benchmark rate to cover its costs and generate a profit. The spread can vary from bank to bank and depends on several factors, such as the loan term, the loan amount, and the applicant’s risk profile.
• Other fees: In addition to the interest rate and the spread, the cost of money may also include other fees, such as loan processing fees, appraisal fees, and insurance costs.

How does the cost of money affect the economy?

The cost of money is an important factor for the economy, as it influences the investment and consumption decisions of households and businesses.

• When the cost of money is low: Households and businesses are more likely to borrow money to invest and consume, which can stimulate economic growth.
• When the cost of money is high: Households and businesses are less likely to borrow money, which can slow down economic growth.

Practical Example

If you are applying for a mortgage to buy a house, the cost of money will be represented by the interest rate the bank applies. This rate will be influenced by the ECB’s benchmark interest rate, the bank’s spread, and any other fees.

Inflation

Inflation is an economic phenomenon that indicates a general and sustained increase in the prices of goods and services over a specific period. This means that, with the same amount of money, you can buy fewer goods and services over time.

How is inflation measured?

Inflation is measured using the Consumer Price Index (CPI), which tracks changes in the prices of a basket of goods and services representative of household consumption. The CPI is calculated by the National Institute of Statistics (ISTAT) in Italy and by similar bodies in other countries.

What are the causes of inflation?

Inflation can be caused by several factors, including:

• Increase in demand: If the demand for goods and services exceeds the supply, prices tend to rise.
• Increase in production costs: If companies’ production costs increase (for example, due to rising prices of raw materials or energy), they may pass some of these costs on to the prices of their products.
• Increase in the money supply: If the amount of money in circulation increases faster than the production of goods and services, the value of money decreases and prices increase.

What are the effects of inflation?

Inflation can have several effects on the economy and society, including:

• Erosion of purchasing power: Inflation reduces the purchasing power of households, which is the quantity of goods and services they can buy with their income.
• Reduction in the value of savings: Inflation reduces the real value of savings, as money loses value over time.
• Increase in interest rates: To combat inflation, central banks may raise interest rates, which can make borrowing more expensive for households and businesses.
• Economic uncertainty: High inflation can create economic uncertainty, as it makes it difficult for households and businesses to plan for the future.

Practical Example

If inflation is 2%, it means that the prices of goods and services have increased by an average of 2% in one year. This means that if a product cost $100 last year, this year it will cost about $102.

General Economic Conditions

The term “general economic conditions” refers to the overall state of a country’s or region’s economy at a given time. It provides a snapshot of the economic situation, highlighting the key factors that influence production, consumption, employment, investment, and trade.

Factors that Determine General Economic Conditions

• Economic growth: The growth rate of the Gross Domestic Product (GDP) is a key indicator of a country’s economic health. A growing GDP indicates an increase in production and income, while a shrinking GDP signals a recession.
• Unemployment rate: The unemployment rate measures the percentage of people who are looking for work but cannot find it. A high unemployment rate indicates a weak labor market and can lead to a drop in consumption and investment.
• Inflation: As explained earlier, inflation is the general increase in the prices of goods and services. High inflation erodes the purchasing power of households and can create economic uncertainty.
• Interest rates: Interest rates influence the cost of money and, consequently, investment and consumption decisions. High interest rates can slow economic growth, while low rates can stimulate it.
• Consumer and business confidence: Consumer and business confidence is an important factor for the economy. When consumers and businesses are optimistic about the future, they are more likely to spend and invest, which can support economic growth.
• Economic policies: Government economic policies, such as fiscal policy (taxes and public spending) and monetary policy (control of the money supply and interest rates), can have a significant impact on general economic conditions.
• External factors: External events, such as global economic shocks, financial crises, wars, or pandemics, can significantly affect a country’s economic conditions.

How are general economic conditions assessed?

General economic conditions are assessed by analyzing various economic indicators, such as those mentioned above. Economists and analysts use these indicators to monitor the economy’s performance and make forecasts about the future.

Why is it important to know the general economic conditions?

Knowing the general economic conditions is important for several reasons:

• For households: General economic conditions can influence households’ consumption, saving, and investment decisions.
• For businesses: General economic conditions can influence businesses’ investment, production, and hiring decisions.
• For governments: General economic conditions can influence governments’ economic policy decisions.
• For investors: General economic conditions can influence investors’ investment decisions.

Rate Type

In the context of mortgages, the term “rate type” refers to how the interest on the borrowed capital is calculated and applied. There are mainly two types of rates:

1. Fixed Rate

• Meaning: A fixed rate is an interest rate that remains unchanged for the entire term of the mortgage. This means that the amount of the monthly (or periodic) payment the borrower has to make will remain constant over time, regardless of market fluctuations.
• Advantages
  • Certainty and stability: It offers the borrower the security of knowing the exact amount of the payments in advance, making financial planning easier.
  • Protection from rate fluctuations: The borrower is protected from any increases in market interest rates.
• Disadvantages
  • Higher initial cost: Typically, the initial fixed rate is higher than an initial adjustable rate.
  • No benefit from potential rate drops: The borrower does not benefit from any decreases in market interest rates.

2. Adjustable Rate

• Meaning: An adjustable rate is an interest rate that can change over time, based on the performance of a benchmark index, such as the Euribor (Euro Interbank Offered Rate). The Euribor is the average rate at which major European banks lend money to each other in the short term.
• Advantages
  • Lower initial cost: Typically, the initial adjustable rate is lower than an initial fixed rate.
  • Possibility of benefiting from rate drops: If market interest rates decrease, the mortgage’s adjustable rate will also decrease, resulting in lower payments.
• Disadvantages
  • Uncertainty and instability: The payment amount can vary over time, making financial planning more difficult.
  • Risk of rate increases: If market interest rates increase, the mortgage’s adjustable rate will also increase, resulting in higher payments.

Other Rate Types

In addition to fixed and adjustable rates, there are other less common rate types, such as:

• Hybrid rate: The interest rate is fixed for an initial period and then becomes adjustable.
• Capped rate: The adjustable rate has a maximum limit (cap) that it cannot exceed.
• Balanced rate: The interest rate is a combination of a fixed rate and an adjustable rate.

Which rate type to choose?

The choice between a fixed and an adjustable rate depends on the borrower’s needs and risk tolerance. In general:

• A fixed rate is more suitable for those seeking security and stability, who prefer to know the exact payment amount in advance.
• An adjustable rate is more suitable for those willing to accept a certain degree of risk and hope to benefit from potential interest rate drops.

It is important to carefully evaluate the pros and cons of each rate type and compare different offers from banks before making a decision.

Loan Term

The loan term, also called the amortization schedule or repayment plan, refers to the period agreed upon between the borrower (who receives the loan) and the bank (or lending institution) within which the debt must be fully repaid. In other words, it is the number of years (or months) required to pay off the mortgage through periodic payments.

How the Loan Term Works

The loan term directly affects the payment amount and the total cost of the financing.

• Payments: A mortgage with a longer term will have lower monthly payments, as the loan amount is spread over a longer period. Conversely, a mortgage with a shorter term will have higher monthly payments.
• Total cost: A mortgage with a longer term will result in a higher total financing cost, as interest will be paid over a longer period. Conversely, a mortgage with a shorter term will result in a lower total cost.

Choosing the Loan Term

The choice of the loan term depends on the borrower’s needs and financial capacity.

• Longer term: This may be preferable for those who want lower monthly payments and have less immediate spending capacity. However, it should be noted that the total financing cost will be higher.
• Shorter term: This may be preferable for those with greater immediate spending capacity who want to pay off the debt more quickly, thus reducing the total interest cost.

Factors Influencing the Loan Term

The loan term can be influenced by several factors, including:

• Loan amount: High-amount mortgages may require a longer term to be repaid.
• Interest rate: A higher interest rate can lead to higher payments and thus a longer loan term.
• Borrower’s age: Banks may have age limits for granting long-term mortgages.
• Bank policies: Each bank may have different policies regarding the maximum term of the mortgages it offers.

Practical Example

If you are applying for a €100,000 mortgage, the loan term will determine the monthly payment amount and the total financing cost.

• 20-year term: The monthly payments will be lower, but the total financing cost will be higher.
• 10-year term: The monthly payments will be higher, but the total financing cost will be lower.

Loan Amount (Loan-to-Value, LTV)

The loan amount, often expressed as Loan-to-Value (LTV), is a fundamental concept in the world of real estate financing. It represents the percentage of the property’s value that the bank is willing to grant as a loan to the borrower.

Calculating LTV

LTV is calculated by dividing the requested loan amount by the property’s value and multiplying the result by 100.

Example

If you are buying a house worth €200,000 and request a €160,000 mortgage, the LTV will be 80% (160,000 / 200,000 * 100 = 80%).

Importance of LTV

LTV is a crucial indicator for the bank in assessing the mortgage’s risk. A higher LTV means the bank is lending a larger percentage of the property’s value, which increases the risk of loss in case of borrower default. For this reason, banks tend to offer lower interest rates for mortgages with lower LTVs and vice versa.

Maximum LTV

In Italy, the maximum LTV allowed for mortgage loans is generally 80%. This means the bank cannot grant a loan exceeding 80% of the property’s value. However, in some cases, such as for first-time homebuyer mortgages for young people under 36, the maximum LTV may be higher.

Impact of LTV on the Mortgage

LTV influences several aspects of the mortgage, including:

• Interest rate: As mentioned earlier, a higher LTV results in a higher interest rate.
• Mortgage payment: A higher LTV can result in a higher mortgage payment, as the amount to be repaid is larger.
• Additional costs: In some cases, banks may require mandatory mortgage insurance for LTVs above a certain threshold.

How to Improve LTV

If you want to get a mortgage with a lower LTV and thus more favorable terms, you can:

• Increase your down payment: Pay a larger sum of money as a down payment for the property purchase.
• Choose a lower-value property: Opt for a less expensive house.
• Improve your credit profile: Show the bank that you are a reliable borrower with a good credit history.

Applicant’s Profile

In the context of a mortgage application, the term “applicant’s profile” refers to the set of personal, financial, and employment characteristics of the person applying for the loan. The bank uses this information to assess the applicant’s creditworthiness and decide whether to grant the mortgage, under what conditions, and at what interest rate.

Elements of the Applicant’s Profile

1. Personal data: name, surname, date and place of birth, residence, marital status, number of dependents. This data is used to identify the applicant and assess their family stability.
2. Employment situation: type of contract (permanent, fixed-term, self-employed, etc.), length of employment, net monthly income, employment sector. This data is crucial for assessing the applicant’s ability to repay the loan.
3. Financial situation: liquid assets (checking accounts, deposits, investments), real estate assets (ownership of other properties), other outstanding debts (personal loans, credit cards, etc.). This data is used to assess the applicant’s financial stability and their ability to handle unforeseen events.
4. Credit history: presence of negative reports (late payments, protests, foreclosures), regularity in payments of previous loans. This data is essential for assessing the applicant’s creditworthiness and their ability to honor commitments.

How the Applicant’s Profile is Assessed

The bank uses several tools to assess the applicant’s profile:

• Document analysis: The applicant must provide the bank with a series of documents attesting to their employment, financial, and asset situation.
• Credit Bureau check: The bank consults the Bank of Italy’s Credit Bureau (Centrale Rischi), a database that collects information on the debts and credit history of registered individuals.
• Debt-to-income ratio calculation: The bank calculates the ratio between the hypothetical mortgage payment and the applicant’s net monthly income to verify that the payment does not exceed a certain percentage of income (usually 30-35%).

Importance of the Applicant’s Profile

The applicant’s profile is crucial for mortgage approval and for determining the contractual conditions. A solid profile, characterized by a stable income, a good credit history, and a good financial situation, increases the chances of obtaining the mortgage on favorable terms. Conversely, a weak profile can lead to the rejection of the application or the granting of the mortgage on less favorable terms.

How to Improve Your Profile

If you want to improve your applicant profile, you can:

• Increase your income: Look for a higher-paying job or take on side jobs.
• Reduce your debts: Pay off any outstanding debts or consolidate them into a single loan with a lower interest rate.
• Build a good credit history: Always pay the installments of any current loans on time and avoid accumulating late payments or defaults.

Bank’s Spread

The bank’s spread in the context of mortgages represents the profit margin that the lending institution adds to the benchmark rate to determine the final interest rate of the mortgage. In other words, it is the difference between the interest rate applied to the customer and the interbank market’s benchmark rate.

How the Spread Works

The spread is expressed in percentage points and is added to the benchmark rate to get the final mortgage interest rate. For example, if the benchmark rate (e.g., Euribor) is 2% and the bank’s spread is 1%, the final mortgage interest rate will be 3%.

Factors Influencing the Spread

The spread applied by the bank can vary based on several factors, including:

• Rate type: The spread for fixed-rate mortgages is generally higher than for adjustable-rate mortgages, as the bank assumes the risk of any increases in market rates.
• Loan term: The spread may increase as the loan term increases, as the bank is exposed to greater risk for a longer period.
• Loan amount (LTV): A higher LTV can result in a higher spread, as the bank assumes greater risk in case of borrower default.
• Applicant’s profile: A higher-risk profile (e.g., low income or a negative credit history) can result in a higher spread.
• Bank’s business policies: Each bank has its own business policies and may decide to apply different spreads based on its market strategies.

Importance of the Spread

The spread is a fundamental element in the cost of a mortgage, as it directly affects the amount of the payments and the total cost of the financing. Therefore, it is important to compare offers from different banks and carefully evaluate the proposed spread before choosing a mortgage.

Negotiating the Spread

In some cases, it is possible to negotiate the spread with the bank, especially if you have a good credit profile and are requesting a large loan amount. However, the ability to negotiate the spread depends on the bank’s business policies and the market situation.

Conclusions

In conclusion, understanding the factors that influence a mortgage interest rate is crucial for anyone considering buying a home. Knowing the meaning of terms like cost of money, inflation, LTV, bank spread, and applicant profile can help you make informed decisions and negotiate the best possible terms with the lending institution.

It is important to remember that the mortgage market is constantly evolving, influenced by economic and political factors at the national and international levels. Therefore, it is advisable to stay updated on the latest trends and consult with industry experts to get personalized advice.

Finally, choosing the right mortgage depends on the needs and financial capabilities of each individual. Carefully evaluating the different options available, comparing offers from banks, and considering your long-term goals are fundamental steps to making a conscious and satisfactory choice.

Frequently Asked Questions