This question was asked back in the days of cheap money. Now, mortgage rates have quadrupled for some folk.
While contemplating the consequences of a sharp increase in mortgage rates, I devised an interesting exercise for those with mortgages that allow overpayments.
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 that Canadian mortgage rules differ, and interest rate calculations are not accurate, let’s use these numbers as a basis for our model.
The question is, can you afford if your mortgage rate suddenly doubled when you had to renew your mortgage? It’s time to put your abilities to the test! As you can see from the table, there’s a difference of $610 every month. So, why not increase your mortgage payment by that amount for a period of time? Don’t hesitate, give it a try for six months and see if you can handle the additional expense. If you can, then make this payment for the rest of your mortgage term, and watch your principal shrink!
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 is $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 current monthly payment is actually lower than what it would have been if you had continued paying $1930 per month. Moreover, if you continue with the same payment, you will be able to pay off the principal of your loan by about $185 per month, which is more than the normal payment amount. This is actually beneficial for you.
Anybody thinking of trying this idea out?
No one will take a financial writer seriously if he does not know the difference between “principal” and “principle”. Please!!!!
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.
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!
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.
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!