Case study: what if mortgage rates double?
Think of your current financial reality.
Then imagine mortgage interest rates are doubled.
8% instead of 4%.
What would that picture look and feel like?
Would you be able to handle it?
Do you have too much debt?
Remember, there was a time in Australia where mortgage rates were higher than 10%. It isn’t beyond the realms of possibility.
Whilst this is a large leap from current commercial rates, it is deliberately intended to get you thinking. Many people do need to review their debt situation.
In progressing, improving and changing behaviour, if often helps to have accountability front and centre in such endeavours. This is one key source of value we provide clients where it relates to their finances.
So, what if interest rates were instead 1 or 2% higher? Let’s look at a case study on this to illustrate.
Bob and Jenny are married, in their early 40’s, with 3 children of school age.
Bob is an IT analyst who earns $150,000 per year and Jenny is a lawyer earning $180,000. They know they have good incomes, and as a result know that they can afford most things. The unintended consequence, which they vaguely appreciate, is that they therefore don’t save in a structured way.
Knowing that they can ‘afford most things’ in their case breeds money complacency.
Their life is busy, hectic and they are always dashing from here to there trying not to be late for the next commitment. Guitar lessons, swimming and the like. Not to mention Jenny’s work commitments as a lawyer and requirement to be doing business development out of hours too, to bring in more billable work.
They each have a super fund that they haven’t looked at much, and a home worth $800,000 or at least they think it is. With the current Perth property market as it is, it could well be $700,000 if they had to sell it soon. They do have $10,000 worth of shares that have been bought in a couple of ‘blue chip’ companies.
They have a home mortgage with $622,000 owing at 4% interest rate with WhichBank. Thankfully they pay off their credit card each month and don’t have personal debt, like so many people do. There is 25 years to go on their home loan. They always pay $100 per month more than the minimum repayment of $3,283.15 per month.
What is the difference if interest rates increase?
Current: Assuming they only pay their minimum loan amount, the total interest payments over the course of the loan would be $362,943.54, assuming interest rates remain constant.
1% higher: Repayment increases to $3,636.15 per month where interest rates are 1% higher than current, which is $353 per month higher.
Total interest payments over the course of the loan, assuming constant interest rate is $468,845.02.
This is $105,901.48 more interest cost on the lifetime of the loan versus current.
2% higher: Repayment increases to $4,007.55 per month as the minimum, $724.40 per month more. Total interest payments over the course of the loan, assuming constant interest rate is $580,266.42.
This is $217,322.88 more interest cost on the lifetime of the loan versus current.
Interest rates double to 8%: Minimum repayment is now $4,800.70 per month, $1,517.55 per month more than current minimum repayment.
Total interest payments over the course of the loan, assuming constant interest rate is $818,209.07.
This is $455,265.53 more interest cost on the lifetime of the loan versus the current situation.
Making better use of savings capacity
Bob and Jenny do have a savings capacity. However, their income doesn’t get effectively used because they are either too busy or too busy and complacent.
With the help of their adviser, they realised that they could save or invest $4,000 per month, based on their current levels of home repayment. Without sitting down in a structured way to work this out, they just would not have got around to it.
Based on the advisory process they determined they had competing objectives of which paying off the mortgage was one. They used $2,000 per month of current savings capacity to repay the mortgage more quickly, with the rest being directed elsewhere for other objectives.
Using the current interest rate scenario, an additional $2,000 per month enables them to repay $5,283.15 per month. Importantly this was done in an automated, ‘don’t have to think about it’ kind of way. Bob and Jenny are lucky. Even in a doubling of interest rate scenario, they could still afford to pay the mortgage. Rest assured, most people in this scenario would not be so lucky. Pause and reflect on your own scenario for a moment to consider how it would impact you.
With the additional $2,000 per month being paid off the loan per month, assuming interest rates remain at the current level, the total remaining interest payments is $169,109.10, with the loan estimated to be paid off 12.5 years earlier. All with simply being more effective with current cashflow and still having a good lifestyle. A large potential interest cost saving on the term of the loan.
Part of the role of their adviser is to check how effectively they are sticking to their objectives (of which additional repayments to mortgage is one) and make sure that ‘life doesn’t get in the way’. Or more simply, to keep them accountable to their own objectives.
Bob and Jenny are on a much-improved track now, which will add up to a meaningful difference to their financial security. If interest rates were to double at some stage in the future, they are on a far better path to handle it.
What about you?
If you realise that further action is needed in your own life, what is the first step you are going to take?
We wish you an abundance of financial security, good health and happiness and welcome a discussion over coffee.
About the author
Sam Gray is principal adviser and director of Incito Wealth. Sam runs Incito Wealth with passion and an innovative heart-centred and purpose-driven approach, with the highest intent of serving and inspiring people to better life outcomes. In a world where people often don’t feel ‘heard’ or ‘valued’, Sam is particularly keen to listen well and cares about your well-being, both financial and otherwise. Sam is author of Money Mastery: the wise sage and the money journey.
Note: calculations have been done with https://www.yourmortgage.com.au/calculators/extra-lump-sum-payment/. You can use this website to play around with variables related to your own situation.
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The views expressed in this article are solely those of the author; they are not reflective or indicative of Millennium3 Financial service’s position and are not to be attributed to Millennium3. They cannot be reproduced in any form without the express written consent of the author.
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Disclaimer: Millennium3 Financial Services Pty Ltd ABN 61 094 529 987 AFSL 244252. The information provided in this document is general information only and does not constitute personal advice. It has been prepared without taking into account any of your individual objectives, financial solutions or needs. Before acting on this information you should consider its appropriateness, having regard to your own objectives, financial situation and needs. You should read the relevant Product Disclosure Statements and seek personal advice from a qualified financial adviser. From time to time we may send you informative updates and details of the range of services we can provide. If you no longer want to receive this information please contact our office to opt out. The views expressed in this publication are solely those of the author; they are not reflective or indicative of Licensee’s position, and are not to be attributed to the Licensee. They cannot be reproduced in any form without the express written consent of the author.