For many people, taking out a mortgage is the only way they can buy a home. Therefore, simply signing the mortgage agreement is one of the most important decisions of their lives, since at that moment they are not only committing to repaying the loan in the future, but also agreeing to pay interest and fees, as well as meeting the agreed-upon deadlines.

However, it’s important to keep in mind that the terms of this contract are usually flexible and that homebuyers have various options for improving their financing terms. Among these is early mortgage repayment, a very attractive option that achieves a twofold benefit: reducing both interest and monthly payments. That’s what we’d like to discuss with you today at CULMIA.

What is mortgage amortization?

If we look at the basic concept, the RAE defines amortization as “Repaying the money (from a debt or loan), generally through periodic payments”. So, when we talk about the amortization period of a mortgage, we’re referring to the timeframe we initially agreed upon with the bank to make the payments and, therefore, repay both the loan and the interest.

In this regard, the Bank of Spain notes that paying off a mortgage is typically a long-term process and that, when choosing its term, it is important to keep in mind that:

• The longer the term (with all other loan terms remaining the same), the lower the monthly payments will be, but the total interest will also be higher.
• The longer the term, the greater the likelihood of changes in both the terms of the loan and the borrower’s circumstances and needs. This is clearly the case with adjustable-rate mortgages, since their interest rates are tied to benchmark indices such as the Euribor.

In Spain, it’s common to end up taking out a 30-year or even 40-year mortgage, provided the bank approves it. In fact, according to a 2021 study by “Idealista Hipotecas, ” more than 50% of people who applied for a mortgage between 2019 and 2021 will not have paid off their debt by the time they turn 65.

Early Mortgage Repayment

From the homebuyer’s perspective, the main advantage of a mortgage is that it allows them to spread out payments over time, which provides some peace of mind when it comes to making each installment. But that’s not the only benefit, because under normal conditions, the buyer also gains the right to make early payments, with all the benefits that entails.

Thus, if we turn once again to the Bank of Spain, it defines early mortgage repayment as the option to “repay part of the principal borrowed during the term of the loan (before its maturity).” This must have been agreed upon in advance by both parties to establish the terms under which this transaction will take place.

Types of Early Mortgage Repayment

There are two ways to make an early mortgage payment. The most common is a partial payment, in which you pay off a portion of the outstanding balance. The alternative is to make a full payment, that is, to pay off the entire debt in order to obtain the mortgage to be removed from the property registry. Furthermore, keep in mind that in this case, the mortgage lien is not automatically removed from your property, so you’ll need to complete this process yourself.

Ways to Make an Early Mortgage Payment

If we are able to make an early payment on our mortgage, we can choose between two repayment options:

• Repayment of an installment (whether principal or interest): As we reduce our debt, we have the option to ask the bank to reduce the amounts of the remaining installments we still have to pay. This makes it easier for us to manage these payments, and it also reduces the total interest on the loan, while maintaining the repayment term we initially agreed upon.
• Term Reduction: An alternative to reducing the installment amount is to shorten the loan term, so that we can pay off the loan sooner. This means that the amount of future installments will not change, but the number of installments will be reduced.

If our concern is the amount of interest we’ll have to pay in the long run, it’s important to keep in mind that shortening the term is usually the most cost-effective option for making early payments on mortgage. The reason is that the shorter the term, the less time there is for interest to accrue, as well as less exposure to benchmark rates (if the mortgage is variable-rate or hybrid).

Possible Penalties for Early Mortgage Repayment

For all these reasons, if a homeowner manages to save or set aside a significant amount of money, making an early payment on their mortgage can be an excellent way to come out ahead in the long run. However, it’s also important to keep in mind that financial institutions may impose a penalty for this action by charging a fee.

In any case, this situation must be clearly stated in the mortgage contract. There is also another key point: the law sets limits on these fees. Specifically, mortgage loans taken out on or after June 16, 2019, are subject to the following caps:

• For variable-rate mortgages, the fee can be as high as 0.25% if the payment is made within the first three years after signing, or 0.15% in the fourth and fifth years.
• For fixed-rate mortgages, the fee and the term are longer: up to 2% for the first 10 years and 1.5% for the remaining years.

All of this encourages us to consider whether or not there are fees when looking for the best mortgage, especially if the buyer anticipates having the opportunity to prepay the mortgage later on. It also prompts us to consider whether any exemptions may be in effect at a given time, since, for example, during 2024, early mortgage repayment does not incur fees for variable-rate loans.

How to Request Early Mortgage Repayment

The process for requesting an early payment of part or all of your mortgage is quite easy to follow:

1. The first step is to contact the bank to request early repayment of the mortgage. To do so, simply schedule an appointment at your usual branch or stop by in person. During the meeting, you will be informed whether the transaction will incur a fee and, if so, the amount of that fee.
2. Next, we must state in writing the date on which we plan to make this unscheduled early payment. By doing so, we will specify the amount paid off and put our decision on record.
3. Finally, we will be able to pay the agreed-upon amount and the fee, if the repayment plan includes it.

Also keep in mind that if the repayment results in the full payoff of the mortgage, the bank may require advance notice and set a date on which the debt can be settled. This is usually a time limit of no more than one month, so that all the necessary procedures can be processed correctly.

Should I save or pay off the loan early?

This is the big question that buyers who have savings or have recently received a substantial sum of money might ask themselves. And the answer isn’t simple, because it will depend on:

• The terms of our mortgage and whether it includes a prepayment penalty.
• The type of mortgage repayment schedule, since in Spain the most common system is the French system. Under this system, during the first few years of the mortgage, a larger proportion of the payment goes toward interest than toward principal, and this trend is later reversed. In this case, it is advisable to pay off the mortgage as soon as possible, since early payments are applied to the principal, and interest is always calculated based on the outstanding principal.
• The Euribor Situation. Of course, in the case of variable-rate mortgages, the benchmark index should also influence our decision: when the Euribor is low, it’s probably best to save and invest that money; whereas if it’s high, it might be best to make an early payment. It all will depend on the return and the current interest rate on our mortgage, because if the former is higher, investing is likely to be the right choice.
• Possible tax benefits. For mortgages taken out before 2013 to purchase a primary residence, there is a significant tax benefit: early repayment allows you to claim a tax deduction of up to 15% of the amount repaid to the bank, with a limit of 9,040 euros per year.
• Our liquidity. The fact is, we’ll need to consider whether we’ll need the money we have saved—and are planning to use to pay off our debt—later on to cover any expenses. If it’s an amount we don’t need, we can use it without any problems to pay off our debt early.
• Planning for the Future. If we’re not concerned about having a long-term mortgage or paying a set amount each month, we might prefer to keep the money we’ve saved or even invest it so it earns us a good return.

We hope you now have a clear understanding of what mortgage prepayment entails, so you can decide whether it’s a better option for you than saving. In fact, remember that we also offer a comprehensive guide to financing, designed to help you implement the best strategies for paying off your home.

Download it now for free by clicking on the banner below. Enjoy!

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