Whenever business ventures or individuals require enormous finance for long-term purposes such as the acquisition of property, business transactions, or debt refinancing, mortgage loans are the easiest and viable options. Secured against immovable assets or land, mortgage loans grant the liquidity of funds and can be returned in a long term.
And the most significant to regulate in the transaction of purchasing a mortgage loan is the interest rate on the mortgage loan. Knowing how this interest is indeed paid in reality and how this affects your overall amount of payment is very crucial in order to become further master of one’s means.
This article describes mortgage loans in more detail, such as how mortgage loan interest is calculated and what to watch for when applying.
What are Mortgage Loans?
Mortgage loans are collateral loans where the lender provides an immovable property—usually a flat, house, land, or business property—to act as security for an advance amount of money. The lender keeps the property until the money is repaid.
They are usually used for:
- Purchasing a new flat or home
- Performing alteration on a property
- Development of a business
- Funding treatment or studies
- Re-financing of high-cost debt
In contrast to unsecured loans, mortgage loans entail longer duration, longer tenor (typically 10 to 20 years), and comparatively lower interest charges since the lender enjoys comparatively lower exposure.
Types of Mortgage Loans
Mortgage loans vary according to loan nature and repayment duration:
1. Home Loan
Home loan is a housing purchase or home loan for a home. The target property to be bought is the security.
2. Loan Against Property (LAP)
It is a house loan when a borrower offers an already owned house or business property rather than procuring funds for non-residential purposes such as business or personal.
3. Commercial Property Loan
It is procured to purchase office spaces, stores, warehouses, or any other commercial structures.
4. Second Mortgage
This refers to lending a loan on the same home with an existing mortgage. The second lender will lend at a higher rate of interest since they are taking more risk.
How Mortgage Loan Interest Rate Works
An understanding of how mortgage loan interest rate is determined will guide your decision in a high-level manner. Interest is merely a charge for borrowing funds and is computed on a fraction of the principal amount.
There are two broad classes of mortgage loan interest rates:
1. Fixed Interest Rate
In this, the fixed rate mortgage loan interest rate remains constant at a given rate throughout the entire loan period or for a number of years. This gives stability and ease of planning because the EMIs are constant.
Advantages:
- Fixedness of EMI
- Ease of budgeting
Disadvantages:
- Could be high in initial stages
- No advantage if market interest rates fall
2. Floating Interest Rate
Also known as variable interest rate, this rate is linked to an external benchmark (such as RBI’s repo rate) and can fluctuate over time based on market trends.
Pros:
- Lower initial rates
- Possible reduction in EMI if interest rates drop
Cons:
- Monthly EMIs may increase
- Financial planning becomes less predictable
How Is the Interest Rate Calculated?
Lenders use various methods of calculating interest on mortgage loans, but most commonly used is the Reducing Balance Method.
Interest is being incurred on the principal of the outstanding balance after every EMI here and not on the amount of the loan taken. So, during the entire period of repayment of the loan, the principal is reduced and therefore the interest component reduces with the clock too.
EMI Formula
EMI = [P × r × (1 + r)^n] / [(1 + r)^n – 1]
Where:
P = Amount of the loan (principal)
r = Rate of interest per month
n = Number of months the loan is retained
Determinants of Mortgage Loan Interest Rate
Mortgage loan interest rate of lenders is different and depends on several determinants:
1. Credit Score
Good credit score (generally 750 and above) indicates good money management and minimizes the risk element of lenders. Prospective customers with good credit score are generally given best rates.
2. Type of Property
Its age, character, and locational level are also at stake. Recency purchasing highly locational assets would primarily be saddled with higher interest rates.
3. Loan Value and Term
Long value loan or extended term can count on higher interest, subject to the borrower’s policy.
4. Occupation and Income
Regular income from a regular employer or running the business adds to your ability to repay, i.e., favorable terms of the loan.
5. Loan-to-Value (LTV) Ratio
This is amount of loan to price of property for sale in market. Lowering LTV ratio (i.e., higher borrower equity contribution) will contribute significantly to lower rates.
Choosing Best Mortgage Loan Interest Rate
When choosing the best mortgage loan, comparing interest rates alone is not sufficient. To procure the best available deal, heed these two:
1. Compare Multiple Mortgagors
The other banks and bankers also charge their mortgagor rate of interest based on their perception of how risky a given mortgagor is. You can generally save most by comparing prices.
2. All the Incidental Charges
Except for the rate of interest, note:
- Processing fees
- Legal and technical fees
- Foreclosure or prepayment fees
- Late fee
3. Choose Flexible Repayment Facilities
Choose lenders offering part-prepayment or foreclosure facility without imposing humongous penalties on you. This will cut an amount later on in the form of interest.
4. Choose EMI Calculators
Computer-calculated EMI calculators allow you to try out various repayment scenarios and choose the loan amount, payment term, and rate of interest that suit your purse best.
Fixed vs. Floating Rate: Which Should You Choose
Your choice of fixed or floating mortgage loan interest rates has to be made on the basis of:
- Market trends: Lock in fixed if interest rates would most likely to increase. Floating will repay you if rates are most likely to decrease in the near future.
- Stability in income: Since the income is not likely to rise, fixed EMIs can be selected. In case you are supposed to earn a higher income in the future, floating EMIs can be re-set.
- Risk appetite: There is definitely reward and risk, but in the case of floating rates, though it was risky under fixed rates, now it is risk-free.
Conclusion
Mortgage loan is an extremely effective money tool through which you can use the value of your home for funding long-term needs. However, knowing about mortgage loan interest rate will save you from money madness and taking proper choices.
Whether buying your ideal home, expanding your business, or marking a milestone, be serious about your money, shop loan offers, and choose an interest rate program that suits you. A thoughtful mortgage loan can open doors without sacrificing your financial health.
