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What If: Your Mortgage Rate Doubled ?

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?

{ 5 comments }

The 4% Draw Down Theory (again)

On Monday I asked about the 4% Draw Down Theory for retirement savings planning, and what readers thought, and as usual there were some very smart responses, and because of that I have come back with a better model for your perusal.

The major comment was that the model didn’t take into consideration Inflation, and that is an important thing to consider in your future. The other important thing to remember is not to retire carrying a large debt load (if any, really).

Our new model is a bit more conservative, where we only have $1M “nest egg” and assume we grow our nest egg by a generous 2%, however, this time assume an inflation rate of 3% (which is comparable to now, unfortunately). With inflation, you need to adjust your withdrawal to compensate for your shrinking spending capabilities, so you increase your yearly “allowance” by 3% (unfortunately each year).

Spoiler Alert: Note the red numbers at the bottom of the table, no you don’t make it to 25 years.

How Long Do We Have?

Also note that your withdrawal doubles in about 24 years following that rule of 72 as well.

Savings Amount at 65 $1,000,000.00  
     
Savings Growth assumption after 65 2.00%  
Assumed Inflation 3.00%  
Initial Amount to draw every year $40,000.00  
Age Amount Left Inflation Adjusted Withdrawal
65 $960,000.00 $40,000.00
66 $938,000.00 $41,200.00
67 $914,324.00 $42,436.00
68 $888,901.40 $43,709.08
69 $861,659.08 $45,020.35
70 $832,521.29 $46,370.96
71 $801,409.63 $47,762.09
72 $768,242.87 $49,194.95
73 $732,936.92 $50,670.80
74 $695,404.73 $52,190.93
75 $655,556.17 $53,756.66
76 $613,297.94 $55,369.35
77 $568,533.46 $57,030.44
78 $521,162.78 $58,741.35
79 $471,082.45 $60,503.59
80 $418,185.40 $62,318.70
81 $362,360.85 $64,188.26
82 $303,494.16 $66,113.91
83 $241,466.73 $68,097.32
84 $176,155.82 $70,140.24
85 $107,434.48 $72,244.45
86 $35,171.39 $74,411.78
87 -$40,769.32 $76,644.14
88 -$120,528.16 $78,943.46
89 -$204,250.49 $81,311.76
90 -$292,086.62 $83,751.12

{ 21 comments }

Pay Day Loan Mortgages ?

After reading about an amazing new movie that premiered in the U.S. called Sharknado (yes it is sharks inside a Tornado) I wondered what would be the most ridiculous (yet remotely plausible) financial idea I could ever think up, and I came up with a Mortgage Company but that uses Pay Day Loans methodologies.

It’s a Tornado with Sharks!

Why would you go to a Pay Day Loan place to finance your house? How should I know, the premise is the dumbest financial idea that is slightly plausible (where slightly plausible should read impossible). OK, so we go down to the BCM Shyster Loan store front and decide we want to buy our new house and get all the capital from the Pay Day Loan store, however, we really only need the money for 2 weeks (as we plan on winning the lottery by then). We have found the home of our dreams, but we need $300,000 to close the deal (luckily when we win Lotto Max that will easily cover this cost), so we wander into the BCM Shyster Loan store and ask for this loan.

Naturally the droid behind the counter is completely thrown aback by this request but goes and asks her “manager” (actually it’s her older brother Ryan, but we won’t go there), and for some reason Ryan (the manager) decides that we have an honest face, and we seem to have a credit card with a credit limit of over $400,000 (which has no balance now), so the “loan” can go through.

So after two weeks when I go back to BCM Shyster Loan store, all I need is $30,000 to pay back this loan (which I easily have from winning the Lotto Max), so the story ends happily, I have the house of my dreams, and there are no sharks in tornadoes flying around my house.

I am planning a sequel post about financing a leveraged stock option short sell using Pay Day Loans.

Any other great financial success stories like Sharknado out there?

I thought Mother F’ing Snakes on the Mother F’ing Plane was the oddest movie idea ever, I stand corrected.

{ 3 comments }

How To Do a Mortgage Schedule

A while ago I showed how the simple PMT() function in Excel can be used to estimate your periodic mortgage payments, if you have all the pertinent information. Today we can use that information to build a mortgage schedule to show your mortgage payments and how they change your Mortgage Principle over time.

First a clarification, as was pointed out by one of my commenters, the PMT() function gives you the wrong periodic payment, due to Canadian Mortgages having their interest compounded semi-annually (twice a year) because in the U.S. it is compounded annually. The fix for this is to change the first entry in your PMT function from:

  • Annual Interest Rate/12 months: which assumes only an annual compounding
  • ( (Annual Interest Rate/2 + 1) ^ (2/12) -1 ) which compensates for the semi-annual compounding

Mortgage Schedule

I like a Mortgage Schedule Table, just because it gives you the ability to understand where you stand in terms of paying off your loans.

Each row of the table will show a payment, how it breaks down in terms of interest and principle payment and how much principle remains after each payment (sounds simple doesn’t it, well it is):

Let’s try this example and show some of the sheet. Assume a $100,000 Mortgage, with an interest rate of 5.95% compounded semi-annually, with a 25 year pay back with monthly payments. We use the PMT() function to find out that our monthly payment will be $636.84.

The sheet layout is the following:

  • Column 1 is the date of each payment
    You can do this for bi-weekly, but I did monthly to make it easy to increment from month to month you simple do =DATE(YEAR(A12),MONTH(A12)+1,DAY(A12))
  • Column 2 shows the real monthly payment
    We already calculated that using the PMT() function
  • Column 3 calculation of how much each payment goes towards the Interest
    This is = Previous balance * Interest rate for that payment period
  • Column 4 calculation of how much each payment goes to the principle
    Total payment – Interest Payment = Principle payment
  • Column 5 the remaining balance on the loan
    Previous Balance – Principle Payment
  • Column 6 total interest paid on the loan so far.
    Previous Interest total + Interest Paid on this payment
Mortgage Schedule
Mortgage Amount $100,000.00 Interest 5.950%
Monthly Payment $636.84 Years 25
Periods/Year 12
Term 300
Start 01-Jun-08
==========================================================================
Date Payment Interest Principal Balance Total Interest
01-Jun-08 $0.00 $100,000.00 $0.00
1-Jul-08 $636.84 $489.80 $147.04 $99,852.96 $489.80

Simple isn’t it?

You just keep going line by line for 25 * 12 times for all the payments and you will see the loan drop to zero. Hopefully tomorrow I will have a link to the example worksheets I set up, for both US and Canadian Mortgages.

More interesting versions of this is if you add an OVERPAYMENT column and then start seeing what happens when you add extra payments early on and how much faster your mortgage gets paid off!

{ 8 comments }

The Free Market and Mortgages (in Canada)

Recently we have had two different lenders come up with “cut-rate” Mortgage (BMO and Manulife) “deals” and both have now withdrawn those “deals” after urging from the Government (specifically the Department of Finance (and in the case of Manulife the Finance Minister himself)).

Thumb Screws

Finance Minister’s New Tool for Dealing with Rogue Banks?

The direct quotes (from the CBC web site) from those involved were:

“My expectation is that banks will engage in prudent lending — not the type of ‘race to the bottom’ practices that led to a mortgage crisis in the United States,” Finance Minister Jim Flaherty said of BMO’s “cut rate” mortgage deal.

and a further quote from the finance minister:

“I had one of my staff call them and indicate my displeasure, which is the same thing I did with BMO, except I called myself,” the finance minister said.

So there you have it my fellow Canadians, evidently there is now plenty of room for the government in our bedrooms (and homes) (to paraphrase Pierre Trudeau).

Now I could not find enough information on what kind of “deal” both BMO and Manulife were offering for these alleged 5 year mortgages, however offering rates of 2.99% and then 2.79% makes these sound like great deals (however, I am willing to hear from folks who are better informed on the entire deal on whether over payments were possible, and whether there might have been hidden penalties as well), but that is not the real point, it is the fact that the “Harper Government” now feels that market forces cannot be trusted.

Have they overstepped their bounds? No, both of the firms could have said, “Sod off!” (however imprudent that might have been), this was not an act of parliament, but it does open an interesting discussion about How Big a Nurse Maid Must the Government Be?

Would there have been a run on “cut-rate” mortgages? There might have been, can you trust banks to not cut their own throats? Rhetorical question now, I suppose, but currently I am fairly certain that I could walk into my bank and after a lot of threatening to leave, I might get a fixed rate of somewhere near 3.5% (without too much work, maybe even lower, who knows).  Would we end up with a Bunch of Stupid Mortgages causing a US-like Sub-prime debacle? Guess we shall never know.

Does the government think Canadians are Financially Stupid? Actions speak louder than words in this case.

Also, I find it hilarious to then hear Tom Mulcair (I am a former Quebecois so that is what we call him there) complaining about the Conservatives interfering with the free market, the irony of hearing a staunch Socialist complaining that the Free Market should decide is not lost on me.

No word on the heir apparent for the Liberals (Mini Trudeau) about whether the Government should be stepping in here.

What do you folks think? Should the government stopped this foolishness or let the marketplace decide?

{ 12 comments }

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