Mortgage

• What they are
• Interested parties
• Strengths and drawbacks
• Expenses
• Underlying rules
• Pitfalls

What they are

A mortgage is the main type of medium- to long-term loan granted by banks and other financial intermediaries and is secured by a lien on a property. It is the most common form of real estate loan and usually has a duration of 5 to 30 years.

The amount borrowed is repaid in fixed or variable instalments due at regular intervals (monthly, half-yearly or other). The amortization schedule is your debt repayment plan and sets out the instalment payments and their due dates.

Each payment is composed of principal, namely repayment of the amount borrowed, and interest, calculated based on a fixed or variable interest rate.

With a fixed-rate mortgage, the interest rate remains that indicated in the contract for the entire term of the mortgage, so you can be sure of the amounts of the individual payments and the total amount of the debt to be repaid.

The disadvantage of this type of mortgage is that you cannot benefit from any reduction in market rates that may occur over the life of the mortgage.

With a variable-rate mortgage, the interest rate may be adjusted at pre-set intervals to follow fluctuations in an index that is usually set by money and financial markets. The main risk is an unsustainable increase in the interest rate, and therefore in the amount of the mortgage instalment payment.

Interested parties

A mortgage is typically used to buy property, in particular residential property, but can also be used to build or renovate a building, or can be taken out to replace or refinance an existing mortgage for the same purpose.

You can receive the entire amount you borrow in a lump sum (usually a percentage of the purchase price or the construction cost of the property) and repay it over time in instalments.

Strengths and drawbacks

A mortgage enables you to obtain a significant amount of money in a lump sum and to repay it over time in smaller amounts for a certain number of years.

It is, however, a serious financial commitment, because it will consume a significant portion of your personal and your family income long term. You must consider carefully whether you can afford this debt before you submit your application and verify it again if your income changes during the repayment period.

If payment (total or partial) is more than 30 days late, the lender can impose additional interest, called an arrears charge, which is added onto the amounts owed.

In the most serious cases, the lender can terminate the contract. If this case, if you are unable to pay the whole of the outstanding debt immediately, you may lose ownership of the mortgaged property.

Expenses

For a given amount financed and a given interest rate:

• the shorter the term of the loan, the higher the individual payments will be, but the amount owed in interest will be lower;
• if the term of the loan is longer, the individual payments will be lower, but more total interest will be owed.

You can find more detail on this in the Calculators section.

In addition to interest and taxes, you will face other costs:

• a tax that is withheld directly by the bank, which is currently equal to 2 per cent (0.25 per cent in the case of the 'prima casa' or primary residence tax break) of the total amount of the mortgage;
• a valuation fee, which many be charged for valuing the property to be mortgaged;
• notary fees;
• fees for recording the lien in land registers;
• the cost of the insurance premium to cover damage to the property and any risks associated with events in the borrower's life;
• a servicing fee, usually an annual charge;
• an arrangement fees, i.e. the reimbursement of the costs of completing the formalities necessary for mortgage disbursement;
• a charge for processing the payment.

The Annual Percentage Rate of Charge (APRC) summarizes the total cost of the mortgage, including the interest rate and other fees and expenses (however, it does not include, for example, notary fees).

Underlying rules

Before applying for a mortgage, you should carefully consider your income and determine how much money you will have available each month after subtracting your mortgage instalment. You must always consider the total amount of debt that you are taking on. Therefore, you must carefully consider whether your income is sufficient to make the periodic payments: unforeseen expenses could arise (for example, medical costs) or your income could fall (job loss or redundancy).

Find out about the different offers by reading the information sheets or by consulting websites and Internet search engines that offer guidance and compare the various mortgages available, paying special attention to the APRC, which indicates the total cost of the mortgage and which all lenders must publish by law in the General Information Sheet.

Remember that at any time you can transfer the loan to another lender, without any additional cost or penalty, through a process called 'portability'. This means that you can pay off the loan amount still owed to the 'old' lender using the sum granted by the 'new' lender and transferring the original lien. The amount will then be repaid on the terms and conditions agreed upon with the new lender.

Once the contract is signed, the lender may report the mortgage to a variety of credit information systems. If the loan amount is €30,000 or more, it will surely be recorded in the Central Credit Register managed by the Bank of Italy.

Pitfalls

A mortgage is something that requires careful medium- to long-term planning. Various studies have shown that people seeking a mortgage sometimes make certain types of mistakes.

One of these is called an 'extrapolation error', which leads us to project what we do know into a future that we don't know, i.e. the present and the past. In periods of falling interest rates, for example, there is a tendency to choose variable interest rates, while when rates are rising, people tend to be risk adverse and instead opt for fixed rates (potential certain loss).

Therefore, if rates have been rising in recent years, we're afraid that they will continue to rise in the future and so we commit to a fixed rate. This is what many people did in 2007-08, when rates were very high. Interest rates then fell and many, many borrowers who didn't renegotiate their mortgages found themselves trapped with much higher rates.

Sometimes even the future influences our choices, the short-term future that is. For example, we allow ourselves to be influenced by interest rate forecasts for the next 2-3 years, because forecasts aren't usually made beyond that period. However, it is a mistake to base our decision on the next 2-3 years when we are taking out a 20- or 30-year mortgage. In the long term, rates go up and down, meaning that after a period of staying high, they tend to fall. Vice versa, periods of low rates are followed by periods of high interest rates. At the moment, rates are very low, but sooner or later they will rise.