What If: Your Mortgage Rate Doubled ?

in Mortgage Rates

So while I was ruminating about what would happen if Mortgage Rates increased violently, I came up with a very interesting exercise to try out for those with mortgages that allow them to make over payments when they wish.

If I assume that current mortgage rates can be achieved at around 4% annually, using the PMT command in most spreadsheets, you can do a very quick comparison to come up with the following simple table.

Interest rates 4.00% 8.00%
Years of Mortgage 25 25
Amount of Mortgage $250,000.00 $250,000.00
Monthly Payment $1,319.59 $1,929.54

Given Canadian mortgage rules are a bit different, and interest rate calculations are not quite right, let’s just use these numbers as an interesting basis for our model.

The question is, can you afford if your mortgage rate suddenly doubled when you had to renew your mortgage? Maybe it’s time to find out if you can. From the above simple table, the difference is about $610 a month, so why not simply increase your Mortgage payment to that amount for a period of time? Maybe experiment and try it for 6 months to see whether you can live with this extra pay out, and if you can, then continue to pay this for the rest of your term, thus lowering your principal?

What might this cause? So at the end of your first five year Term your mortgage schedule for the last few payments might look like:

Payment No
Principal Interest Payment Principal Payment Overpayment
56 $224,613.20 -$748.71 -$436.88
57 $224,176.32 -$747.25 -$436.03
58 $223,740.29 -$745.80 -$435.18
59 $223,305.11 -$744.35 -$434.34
60 $222,870.77 -$742.90 -$433.49

So after five years you will have paid off about $27,000 from your mortgage, a good start, but then if interest rates have somehow jumped to 8% your monthly payment now are $600 more (ouch). (by the way I used the iPMT and pPMT spreadsheet functions for those calculations).

What would happen if at the start of year 3 of your term you started making a $610 overpayments on your loan, what might the end of your 5  year term look like?

Payment No. Principal Interest Payment Principal Payment Overpayment
37 $233,077.61 -$776.93 -$453.34 -$610.00
38 $232,014.26 -$773.38 -$451.28 -$610.00
39 $230,952.99 -$769.84 -$449.21 -$610.00
40 $229,893.77 -$766.31 -$447.15 -$610.00
41 $228,836.62 -$762.79 -$445.10 -$610.00
42 $227,781.53 -$759.27 -$443.04 -$610.00
43 $226,728.48 -$755.76 -$440.99 -$610.00
44 $225,677.49 -$752.26 -$438.95 -$610.00
45 $224,628.54 -$748.76 -$436.91 -$610.00
46 $223,581.63 -$745.27 -$434.87 -$610.00
47 $222,536.75 -$741.79 -$432.84 -$610.00
48 $221,493.91 -$738.31 -$430.81 -$610.00
49 $220,453.10 -$734.84 -$428.79 -$610.00
50 $219,414.31 -$731.38 -$426.77 -$610.00
51 $218,377.54 -$727.93 -$424.75 -$610.00
52 $217,342.79 -$724.48 -$422.74 -$610.00
53 $216,310.05 -$721.03 -$420.73 -$610.00
54 $215,279.32 -$717.60 -$418.73 -$610.00
55 $214,250.59 -$714.17 -$416.72 -$610.00
56 $213,223.87 -$710.75 -$414.73 -$610.00
57 $212,199.14 -$707.33 -$412.73 -$610.00
58 $211,176.41 -$703.92 -$410.75 -$610.00
59 $210,155.66 -$700.52 -$408.76 -$610.00
60 $209,136.90 -$697.12 -$406.78 -$610.00

Interesting, isn’t it? Now you are $13,000 farther into your principal, and when the bank comes back to figure out your new 5 year term, you end up with the following:

Interest rates 8.00%
Years of Mortgage 20
Amount of Mortgage $209,136.90
Monthly Payment $1,749.30

Your monthly payment is actually lower than it would have been, and in fact if you kept up your $1930 monthly payments, you’d still be paying off the principal of your loan by about $185 a month (more than you would normally), not a bad thing either.

Anybody thinking of trying this idea out?

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{ 5 comments }

{ 5 comments… add one }
  • Gil January 11, 2014, 12:15 AM

    No one will take a financial writer seriously if he does not know the difference between “principal” and “principle”. Please!!!!

    Reply
    • bigcajunman January 11, 2014, 6:54 AM

      Agreed. As for people taking me “seriously”, I would have thought my title of “Clown Prince of Personal Finance” might be more of a hindrance.

      Reply
  • Katy January 9, 2014, 9:12 PM

    Interesting idea. I hope people try it out — even if not doubling the interest rate, just upping it to 6% for your example. There’s been a few blogs talking about stress testing this year — is it the new “in” phrase?

    We did a “spin” on this with our mortgage back in 2003 — we doubled up every payment. It was a *bit* more extreme than if the interest rate doubled, but between that and lump sums, we paid it off in 6.5 years. This was done before the housing prices in SK rose up to the Canadian average …. not sure if we could pull it off now!

    Reply
  • Michael James January 9, 2014, 3:48 PM

    This kind of stress-testing makes a lot of sense. I’m having a little trouble with the numbers, though. Shouldn’t the amount of principal paid down go up with each mortgage payment instead of down? I would have thought that the interest payment plus the principal payment would always add up to the total payment.

    Reply
    • bigcajunman January 9, 2014, 5:01 PM

      Yikes, that is WRONG, so I will attempt to remedy that, and show my mistakes as well. My work sheet is not available right now, but I will fix this!

      Reply

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