Mortgage rate

You have $200,000 left on your mortgage. You just had a 5 year fixed term and it expires today.

Do you lock in your mortgage for 5 more years at 5% interest rate and your $1000/month payment?

or

Do you take the variable rate that is currently at 3% and forecasted to rise to 4% next year, 5% the following year, 6% the next year and 7% the final year while still paying your $1000/mth payment?


After 5 years, which method would see you have the smaller principle amount left to pay?

Variable.

With variable you pay less interest when your balance is higher.

Lock in.

Originally posted by Thomaster
Lock in.

What?

There are two reasons why variable is better.

First, as iamtiger mentioned, you abate the principal more in the beginning when the rate is low. This means that when the rate is 6% or 7% it will apply to a smaller principal.

Secondly 1.05^5 > 1.03*1.04*1.05*1.06*1.07, which means that even if you only paid interest+principal at maturity you would still prefer the variable rate.

It makes the difference of less that $2000, but variable is better IF YOUR FORCAST IS CORRECT.

I would lock in the interest rate and not gamble.

Originally posted by forkedknight
It makes the difference of less that $2000, but variable is better IF YOUR FORCAST IS CORRECT.

I would lock in the interest rate and not gamble.

$2000 is 1% of the principal or 1.666% of total payments in this period. Besides, if interest is calculated monthly then I get $2700 difference.

And the forecast being wrong is not necessarily bad. Interest rates can also be lower than forecasted. It all depends how much risk you're willing to accept for the $2000/2700 difference in the principal.

Originally posted by Palynka
And the forecast being wrong is not necessarily bad. Interest rates can also be lower than forecasted. It all depends how much risk you're willing to accept for the $2000/2700 difference in the principal.

Exactly. The real answer, as opposed to the puzzle answer, depends on your personal circumstances and your attitude to risk.

I took a fixed rate out on my first mortgage, purely because I couldn't have afforded it if the rate had gone up.

Originally posted by Palynka
$2000 is 1% of the principal or 1.666% of total payments in this period. Besides, if interest is calculated monthly then I get $2700 difference.

And the forecast being wrong is not necessarily bad. Interest rates can also be lower than forecasted. It all depends how much risk you're willing to accept for the $2000/2700 difference in the principal.

so, you're saying the difference in the remaining principle is $2000 in favour of the variable after 5 years?

I got a difference of about $1040 in favour of the variable rate using a homemade Excel variable rate mortgage calculator. I assumed that interest rate would be static at 5% over the final 15 years of the mortgage in both cases. I agree with the previous posters who said this is almost negligible over the remaining 20 years of the mortage, however I would probably stick with the variable rate as the long-term forecast is subject to significant uncertainty (and may end up much lower than you had predicted!).

In terms of daily cash flow, at the low end of the variable rate you'll be paying around $1100 per month, while at the top end you'll be paying around $1500 per month. The fixed rate will set your monthly payments around $1300. At this rate, you could probably throw the $200 you save in the beginning towards your mortgage and save quite a bit on interest and increase the savings.

Variable sounds like the way to go, but as another poster has already stated, you have to decide how much risk you're willing to accept to save money on this transaction.

Originally posted by uzless
so, you're saying the difference in the remaining principle is $2000 in favour of the variable after 5 years?

No, I get 2700. The 2000 was his calculation.

I used the monthly rate that gives you the annualized x% (1.0x)^(1/12) but some banks actually get more by picking monthly rates as (1+0.0x/12). This gives you an annual rate higher than x%.

(right, I used a $2000 per month payment. Redoing calculations. I get 1408.147)

I assumed 5% compounded monthly, and boy did they get a lousy mortgage for the amount owed..

At any rate, I got these numbers.

5% Fixed - $188,382,29
Variable - $187,000.78

So variable wins after 5 years where absolute numbers are concerned.

HOWEVER... during the last year, variable interest is more than the payment, which means the principle is increasing. This isn't good, depending on your options after 5 years.

I would go with fixed rate, and I might be tempted to make a much higher payment.

$3758.59 a month would pay off the principle amount in 5 years at 5%.

At 5% and $1000 payments a month, it will take a month shy of 36 years to pay it off.

Take the variable, but reevaluate the fixed deals available every year as it becomes steadily more beneficial to fix on years 2, 3, 4 or 5. This is more or less what I tend to go for in real life - variable rate tied to basic rate with no tie ins, but I do occasionally go fixed for a few years. For instance if you can fix after year 2 at 5.25% you pay 3% 4% 5.25% 5.25% 5.25%, which is quite a lot better (about £5600) than fixing at 5%.

A low variable with a small payment can also be good if you are poorish but expect to be earning more in a few years, especially if it has no tie ins.

Anyone know how to derive the formula for interest rate given the principle amount, payments, and number of payments?

The base formula includes both "i" (interest rate per payment) and "(1+i)^-n"... I see no way to combine the two occurrences of i.

I do suppose you could zero in on the interest though, by plugging in rates and getting the answer closer for one of the variables closer and closer to the correct answer.