Mortgage interest rates have been ultra-low for the last few years. Lots of people, including myself, choose to not pay off their mortgage faster than the regular amortisation schedule. However, to determine whether you want to pay off your mortgage or not, it’s not fair to just look at the overall interest rate you’re paying.

## How Mortgage Interest Rates are Set

On my mortgage, the interest rate is 1.40%. However, that is not entirely true. The rate I pay is the rate for mortgages between 65% and 80% LTV ratio. Of course, that’s the rate for my bank, and at the time I closed on the loan.

Would my mortgage be between 80% and 90%, I would have paid 1.70%, below 65% LTV I will pay 1.30%. The reason banks offer lower interest rates for mortgages with lower LTV ratios is that their risk is lower. In the unfortunate scenario where you can’t pay your mortgage anymore, the bank could foreclose on your property.

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With a lower loan to value ratio, the risk that they don’t recover their full mortgage amount is lower. For that lower risk, you get to pay a lower mortgage interest rate.

So we have seen now the LTV, or loan to value ratio, is important to determine your mortgage interest rate.

## What is LTV?

LTV is short for loan-to-value, or the ratio between the open mortgage amount and the value of your property. An example would be a 200,000 euro home with a 100,000 euro mortgage. The LTV ratio in this case is 50%.

You can simply calculate your LTV by dividing the open mortgage amount by the value of your property. It’s important to use the open amount and not the original amount here.

As I’ve mentioned in the previous section, a lower LTV ratio could mean a lower mortgage interest rate for your loan. If you want to lower your interest costs, you could try to lower your loan-to-value ratio.

From the *LTV = outstanding mortgage / property value* we learn that you can lower your LTV by either lowering your debt, increasing your property value, or both.

## Calculating Your True Mortgage Interest Rate

The sticker price of your mortgage is not always the true interest you pay. Because the rate lowers when your loan goes into the next LTV bucket, you can think of your mortgage as a bunch of loans with different interest rates.

Take my loan for example. The following LTV ratios and interest rates are applicable:

- LTV < 65%: 1.30%
- 65% < LTV < 80%: 1.40%
- 80% < LTV < 90%: 1.70%

When my LTV falls below 65%, the interest rate will be a flat 1.30% on the full amount. However, say my LTV is 90%. In that case I can look at my mortgage as being three separate loans:

- Loan 1: 65% of property value
- Loan 2: 15% of property value
- Loan 3: 10% of property value

You can determine the true interest rate on the “three” loans by looking at the interest amount, not the interest rate, you pay for these loans when you go into the next LTV bucket. Because the mortgage interest rate goes up for the entire loan, the effect on the small, virtual loans is way bigger.

Let’s calculate some numbers!

## My Mortgage as an Example

As of today, my mortgage amount is 183,400 euros. The value of my apartment is 240,000 euros. That means my LTV is 183,400/240,000 = 76,4%. That puts me in the 65-80% LTV bucket, and means I pay a 1.40% mortgage interest rate over the full loan amount.

However, I want to know what the true cost is of my loan. So I decide to divide the loan into buckets:

Name | LTV | Amount | Interest Rate | Interest Amount |
---|---|---|---|---|

Loan 1 | <65% | 156,000 (65% of 240k property) | 1.30% | 2028 |

Loan 2 | 65%-80% | 27,400 (total amount 183,400 minus 156k) | 1.97% | 539.60 |

Total Loan | 76,4% | 183,400 | 1.40% | 2,567.60 |

Total interest I pay per year is based on the 1.40% mortgage interest rate over the open amount of 183,400 euros. So I pay 2,567.60 per year.

If my mortgage would have been <65%, I would have paid 1.30%. So it’s fair to say I pay 2,028 (1.30% of 65% LTV) over that part of the loan, and *the rest* coming out of the 65-80% LTV part of the loan.

The rest – **bold** in the table – is calculated by taking both the 1.30% interest amount (2,028) and the full mortgage interest amount (2,567.60) and taking the difference.

The interest amount on that part of the loan, therefore, is 539.60, and the effective interest rate becomes 1.97% (539.60 / 27,400).

## Conclusion

So even with a sticker price of 1.40%, I really do have two loans: one at 1.30% and one at 1.97%.

It is important to know this because sometimes the effective interest rate is so much higher than the total price, it might make sense to start paying off part of your loan. Or, when you start to look at taking out an additional mortgage you might decide to not do it.

When I refinanced my apartment and took out some money, I have looked at both the <80% scenario (which I went with) and taking the full 90%. If I were to go with the 90%, the effective rate for me would have been 4.1% on the 80-90% LTV part of the mortgage.

That was simply too high for me to be acceptable, so I went with a slightly lower loan.

**Have you ever considered the true cost of your mortgage? Please calculate your true costs and share them with me in the comments below.**

Now that was definitely a new concept for me. I’m sure that most of readers didn’t have any clue about this! At this moment I only pay rent, but when looking the actual costs of buying a house, I have to calculate the mortgage carefully.

– NF

It’s always smart to calculate carefully.

We have a mortgage with nhg (dont know how to say that in english…) so the interest stays the same

In that case it’s only one loan indeed.

NHG for me as well… but already at 70%… 4 more years to go @4% :(…. what do you think should i pay the fine? And change bank?

I don’t give financial advise. So look for the cheapest option to refinance at another bank, ask for a proforma invoice for the fine, and make your decision. Keep in mind that some of the costs could be tax deductable.

I didn’t know that the LTV ratios differ from bank to bank (or hypotheeker). I have Rabo mortgage and these ratios are: %67.5 and %90. So if LTV < %67.5 it's fixed for the rest.

I did this LTV calculation and decreased the interest rate this year (as the house prices go above, it was very easy)

I am also looking at interest averaging “rentemiddeling” at the moment, but have not calculated it yet like you.

By using buckets you always get higher calculated rates. Banks do not see it as a bucket sytem, but as a limit system. You just pay 1.4% when passing the 65% limit.