If you are in the process of applying for a mortgage, you may have come across some terms that seem unfamiliar. One of these terms is the effort rate. In this article, we will clarify what this concept means and explain why it is so important in the mortgage application process.
What is the effort rate?
The effort rate is an indicator used to assess a borrower’s credit risk. In practice, it shows the relationship between the monthly mortgage payment and the family’s income, and it is expressed as a percentage. For example, if the monthly payment is €700 and the family’s net income is €1,000, the effort rate is 70%. This means that 70% of the income is being used to pay the mortgage. In other words, only 30% of the income remains available to cover all other expenses, such as utilities, food, and other living costs.
What does the bank have to do with this?
The bank is primarily concerned with the likelihood that the borrower will be able to make their mortgage payment, rather than how they spend their money (although spending habits can indicate risk behaviors). The bank’s main priority is to ensure that the borrower can repay the loan so the bank can recover its money and make a profit. Therefore, a higher effort rate indicates greater risk for the bank, which could result in the bank either rejecting the application or making the loan more expensive.
Are there other factors to consider?
Depending on the bank, other factors are also considered when calculating the effort rate. For example, if there are children in the family, the bank will adjust its calculations to account for fixed expenses for each child. Here, the experience of the mortgage consultant is crucial, as different banks have varying methods of calculation.
What if I have multiple loans?
If the borrower has other loans, the calculation of the effort rate will also be adjusted. In this case, the monthly payment of the new mortgage loan will be added to the payments of any other loans. If the effort rate is too high, the risk is considered elevated, and the borrower will need to make some decisions. One option, if the property valuation allows it, is to increase the mortgage loan amount to pay off smaller loans, which would reduce the overall monthly payment (because it increases the loan term and reduces the interest rate).
The effort rate is a risk indicator that plays a significant role in the approval of any credit application, whether it’s a mortgage loan or a personal loan. It is generally advised that the effort rate should not exceed 40%, ensuring that the borrower has enough income left to cover essential expenses without compromising their financial stability. If you want to understand whether your mortgage application is viable and find the best mortgage offer, we suggest you fill out the form below.
