In this article, we will explain what interest rate risk compensation is and how it is calculated. Interest rate risk compensation is an important concept in the world of finance that can have a significant impact on your loans and credits. If you’re interested in learning more about how this compensation works and how it can affect you, keep reading to find out.
What is interest rate risk compensation?
In a mortgage, one of the commissions that generates the most doubts among users is the interest rate risk compensation. This commission is only applicable to mortgages with a fixed or mixed interest rate, provided that the fixed rate period exceeds 12 months.
The interest rate risk compensation is the amount that a financial institution can charge to a debtor client of a mortgage loan if the client cancels it before the initially agreed maturity date, causing a loss to the institution if the cancellation occurs during a period of falling interest rates. This compensation also applies if total, partial, or subrogated repayments are made on these mortgages to another institution.
The interest rate risk compensation is used to minimize the risk that changes in interest rates will negatively affect the income and expenses of financial institutions. For example, if after a few months, the market interest rates decrease considerably and the borrower cancels the loan, the bank or savings bank may lose money because, in case of lending the refunded amount again, it will do so at a clearly lower interest rate. To compensate for this loss, this mechanism of interest rate risk compensation is implemented.
How is the mortgage compensation calculated in 2023?
The interest rate risk compensation is calculated based on a series of factors, such as the term of the operation, the applicable interest rate, the historical evolution of interest rates, and expectations of their future evolution. In this regard, financial instrument valuation techniques are used to estimate the value of interest rate risk compensation.
It should be clear that the commission applies exclusively for the time remaining to be paid during the fixed-interest period, as the commission is not applicable in periods of time that coincide with variable interest rates.
To calculate the amount of the commission, you must apply the percentage of that commission to the sum of all remaining mortgage payments until the end of the fixed-interest period.
What requirements must be met for the financial institution to charge interest rate risk compensation?
To be able to charge interest rate risk compensation, it is necessary to meet a series of requirements, which vary depending on the financial institution and the type of operation that has been contracted:
- The amount must be agreed upon in the contract.
- It can only be charged if the cancellation causes a loss to the institution.
- It cannot be charged on variable-rate loans whose revision occurs every twelve months or less.
- If there is capital loss and the review period is longer than a year, the compensation will be the agreed percentage on the outstanding capital at the time of cancellation or on the amount of the capital loss.
- That the mortgage is on a residence and the debtor is a natural person.
- That the borrower is a legal person who pays taxes in the Corporate Tax under the tax regime for small businesses.
In addition, it is important to note that compensation for interest rate risk does not distinguish between whether the cancellation occurs as a result of a subrogation or not, that is, the treatment will be identical in both cases.
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Example of compensation for interest rate risk:
Let’s take the case of a person who takes out a variable rate mortgage with a financial institution. In this case, the monthly payment of the mortgage can vary depending on the evolution of interest rates in the market. To protect themselves against possible fluctuations in interest rates, the financial institution may include a clause for compensation for interest rate risk in the mortgage contract.
At Ker 2000 we want to give you an example with real data to help you better understand what you are reading:
Mortgage term: 30 years
Fixed-rate term: 5 years
Monthly mortgage payment: 700 euros/month
Months already paid: 36 months (3 years)
Signed interest rate risk commission: 2.70%
Only 2 years of fixed-rate payments remain. This is 24 months, so the commission will be applied to 24 months of payments.
Amount to apply commission: €700/month x 24 months = €16,800
Total commission to be paid = 2.70% x €16,800 = €453.60
The commission of €453.60 would be the result in case of total cancellation of the mortgage or subrogation. To this commission, the cancellation compensation commission agreed upon in the mortgage contract signing would have to be added.
In the case of partial repayment, the commission would be proportional to the reduction in the payment.
Why is it important to keep all this in mind when signing future mortgages? Because the current interest rate in Spain for mortgages in 2023 is around 3%. Even in the second half of the year, we could see fixed rates at 4%.
Compensation for interest rate risk is an important tool to protect financial institutions against fluctuations in interest rates.
It is important to keep in mind that this measure carries an additional cost for homebuyers, so it is recommended to carefully analyze the conditions established in the contract before hiring any financial product. In addition, it is essential to stay up to date with the latest news and changes in interest rates in order to make informed and appropriate financial decisions based on each person’s needs and objectives.
If you are looking for homes for sale in Valladolid, you are in the right place. At Ker 2000, we have a team of experts who will help you with the purchase and sale of your home.
We are a real estate agency located in Valladolid with the aim of accompanying our clients in the search for their new home, from the beginning to the closing of the sales agreement and its subsequent maintenance. As professionals in the real estate sector with extensive experience, we advise you by clarifying any doubts and solving any inconvenience. Get the best price for your future home and the best financial agreement that guarantees your peace of mind!