The cost of living

[lpm]

Banks can do what they like, they can always use derivatives to swap between fixed and floating. When they give you a 5 year fixed, they hedge it back in the derivatives market to match the average tenor of their own funding sources. That's a basic task of a bank/building society Treasurer.

After a 10 year fix, sure you might be facing a nasty jump in rates. However you are 10 years down the line with repayments, plus house prices normally will have gone up. Hence a lot of equity or loan extension or similar - so it's highly unlikely anyone at 10 years will struggle unless they've had a life changing event like job loss or divorce. The same doesn't apply to 2 year fixes. These are better seen as variable rate with an initial discounted fixed rate to entice customers in.

[dyqik]

(30 year fixed rate holder here...)

[dyqik]

I don't claim to understand the mortgage market, but a large majority of U.S. mortgages are fixed for the entire life of the loan, usually 30 years. So the idea that banks "can't" do that because of bad experiences in the 1970s or whatever is clearly wrong. But I don't know why.

AIUI, in the US, a lot of high quality mortgages are originated and held by Credit Unions, which don't get as involved in the market overall, as their loans are financed more on deposits and less on debt. There's a lot more diversity in the banking sector as well - many many more local banks and credit unions. Those that do get involved in the market tend to fund loans on debt and then sell the mortgages on.

[Bird on a Fire]

How do these mortgage hikes compare with rental increases over the past decade or so?

Not in a yah-boo way at all - rental increases have been terrible for a lot of communities. If there's a real risk of many people having to move home as a result it's gonna suck.

[dyqik]

How do these mortgage hikes compare with rental increases over the past decade or so?

Not in a yah-boo way at all - rental increases have been terrible for a lot of communities. If there's a real risk of many people having to move home as a result it's gonna suck.

I'd assume that all mortgage hikes have been included in rent, and then added on to for other increased costs and just because.

Here in Boston, annual increases of 25% in rent are currently the norm, if Reddit is to be believed.

[Bird on a Fire]

How do these mortgage hikes compare with rental increases over the past decade or so?

Not in a yah-boo way at all - rental increases have been terrible for a lot of communities. If there's a real risk of many people having to move home as a result it's gonna suck.

I'd assume that all mortgage hikes have been included in rent, and then added on to for other increased costs and just because.

I'm sure that's true of recent rent increases, but they were going up a lot in 2016 when I lived in the UK, in the before times. 10% a year wouldn't be remarkable in many areas. It's why people I know who live in London all keep moving all the time. Buying a place was therefore very attractive, because (AIUI) the mortgage debt doesn't go up as fast as rent, so your payments stay lower and more predictable.

Are mortgages going to hit 10% a year level?

[dyqik]

How do these mortgage hikes compare with rental increases over the past decade or so?

Not in a yah-boo way at all - rental increases have been terrible for a lot of communities. If there's a real risk of many people having to move home as a result it's gonna suck.

I'd assume that all mortgage hikes have been included in rent, and then added on to for other increased costs and just because.

I'm sure that's true of recent rent increases, but they were going up a lot in 2016 when I lived in the UK, in the before times. 10% a year wouldn't be remarkable in many areas. It's why people I know who live in London all keep moving all the time. Buying a place was therefore very attractive, because (AIUI) the mortgage debt doesn't go up as fast as rent, so your payments stay lower and more predictable.

Are mortgages going to hit 10% a year level?

At low mortgage rates, e.g. ~3-4%, 1/2 to 2/3 of a mortgage payment is interest, early in a mortgage. So an increase to 6-8% interest could push that mortgage payment up by 33-67%.

Later in a mortgage, usually more of payment goes against the principal(?) rather than interest, so the increases are smaller.

[Bird on a Fire]

f.ck, 33-67% is a lot.

[dyqik]

f.ck, 33-67% is a lot.

If it comes after five to ten years fixed rate, with inflation and house price increases, the lower end is acceptable - just catching up to inflation. But it's still a shock, and it will f.ck people's finances up.

[Millennie Al]

I don't claim to understand the mortgage market, but a large majority of U.S. mortgages are fixed for the entire life of the loan, usually 30 years. So the idea that banks "can't" do that because of bad experiences in the 1970s or whatever is clearly wrong. But I don't know why.

A long term fixed rate must include a premium to cover the risk that interest rates will rise and cut profits. If too few customers are willing to pay this premium - e.g. by being obsessed with minimising their monthly payments - then it's not worth offering such a product.

[bolo]

I don't claim to understand the mortgage market, but a large majority of U.S. mortgages are fixed for the entire life of the loan, usually 30 years. So the idea that banks "can't" do that because of bad experiences in the 1970s or whatever is clearly wrong. But I don't know why.

A long term fixed rate must include a premium to cover the risk that interest rates will rise and cut profits. If too few customers are willing to pay this premium - e.g. by being obsessed with minimising their monthly payments - then it's not worth offering such a product.

OK, then in the U.S., either the premium is smaller for some reason, or more customers are willing to pay it for some reason. I still wonder what those reasons are. I'm guessing that it's to do with the wider diversity of lenders, as dyqik pointed out. Perhaps it's also related to there being a more developed secondary market? Or maybe something about transaction costs for refinancing?

[lpm]

I don't claim to understand the mortgage market, but a large majority of U.S. mortgages are fixed for the entire life of the loan, usually 30 years. So the idea that banks "can't" do that because of bad experiences in the 1970s or whatever is clearly wrong. But I don't know why.

A long term fixed rate must include a premium to cover the risk that interest rates will rise and cut profits. If too few customers are willing to pay this premium - e.g. by being obsessed with minimising their monthly payments - then it's not worth offering such a product.

This is not correct. The interest rate risk is hedged.

[El Pollo Diablo]

Banks can do what they like, they can always use derivatives to swap between fixed and floating. When they give you a 5 year fixed, they hedge it back in the derivatives market to match the average tenor of their own funding sources. That's a basic task of a bank/building society Treasurer.

After a 10 year fix, sure you might be facing a nasty jump in rates. However you are 10 years down the line with repayments, plus house prices normally will have gone up. Hence a lot of equity or loan extension or similar - so it's highly unlikely anyone at 10 years will struggle unless they've had a life changing event like job loss or divorce. The same doesn't apply to 2 year fixes. These are better seen as variable rate with an initial discounted fixed rate to entice customers in.

Bear in mind that many people will not want to definitely tie themselves in to a mortgage for ten years or more, as they might want to move house at some point, or borrow more for an extension through remortgaging, and the early repayment fees are a strong disincentive to that. Barclays currently offer a 10 year fixed rate (at 5.65%), and the early repayment fee is 5% of the mortgage value, all the way through the fixed term. I can't see a lot of people going for that unless they're very firm that they won't be borrowing extra, or moving house.

[IvanV]

At low mortgage rates, e.g. ~3-4%, 1/2 to 2/3 of a mortgage payment is interest, early in a mortgage. So an increase to 6-8% interest could push that mortgage payment up by 33-67%.

Later in a mortgage, usually more of payment goes against the principal(?) rather than interest, so the increases are smaller.

Repayment mortgages are calculated as a flat payment across the life of the mortgage. The division of the payment into interest and repayment is an afterthought, after application of that principle, as I will show at the end. So it doesn't help to think about it when working out how the payment varies with interest rate.

What is really useful is the Excel formula =PMT(Interest Rate, Years, Loan) which does the work for you. (See notes below) That tells you the annual payment on a loan for a repayment mortgage of a given number of years.

So for a £100,000 loan (as an example) and 25 years, this is how the annual payment varies with interest rate, very quickly calculated with that excel formula. (Your payments might be slightly different due to timing issues - seen notes below.)

2.0% £5,122
3.0% £5,743
4.0% £6,401
5.0% £7,095
6.0% £7,823
7.0% £8,581
8.0% £9,368

Deciding how much is interest and how much is repayment is based on working out what declining balance of the loan would result in the same payment for the remaining period of the loan. So, for example, at 4%, to get a £6,401 payment on a 10 year loan would imply a loan amount of £51,919. So that means you have paid off £48,081 after 15 years. But at 7%, to get a £8,581 payment on a 10 year load would imply a loan amount of £60,270. So you have only paid off £39,730 after 15 years at 7%.

Notes on the Excel formula. The formula operates on the assumption of a particular timing of the payment in the payment period, which you can control with an additional parameter. But if you just divide the payment by 12, it won't be exactly the payment for a monthly payment, because the exact timings won't match what happens with a single payment. If you want to calculate a more accurate monthly payment, you need to use the formula as follows =PMT (Monthly interest rate, Months, Loan). To calculate the monthly interest rate from annual rate, use this formula: Monthly interest rate = (1 + R)^(1/12) - 1 Where R is the annual interest rate. In fact many loan providers, in these days of computers, calculate the daily interest payment using a daily interest rate, so you have a daily charge thus: =PMT(Daily interest rate, Days, Loan). They will then add up the daily interest payments up over a month and charge you that on some date in the month. Or charge you 365/12 daily charges, to even out the monthly payments. The daily interest rate is (1+R)^(1/365)-1. You will also observe the formula produces an -ve answer consistent with accounting principles, which I have suppressed above.

[lpm]

Yes! Spreadsheets! More of this please!

I did have one with the formula for calculating the outstanding balance at future dates. But I've lost it.

[IvanV]

Yes! Spreadsheets! More of this please!

I did have one with the formula for calculating the outstanding balance at future dates. But I've lost it.

I did that calculation above using already_calculated_payment/PMT(rate, years remaining, loan), which gives the fraction of the loan outstanding at the number of years remaining. Arithmetically, that's a bit inefficient, as the fraction is independent of the amount of the loan. If you went back to the underlying formulae, the amount of the loan would cancel out.

[dyqik]

At low mortgage rates, e.g. ~3-4%, 1/2 to 2/3 of a mortgage payment is interest, early in a mortgage. So an increase to 6-8% interest could push that mortgage payment up by 33-67%.

Later in a mortgage, usually more of payment goes against the principal(?) rather than interest, so the increases are smaller.

Repayment mortgages are calculated as a flat payment across the life of the mortgage. The division of the payment into interest and repayment is an afterthought, after application of that principle, as I will show at the end. So it doesn't help to think about it when working out how the payment varies with interest rate.

What is really useful is the Excel formula =PMT(Interest Rate, Years, Loan) which does the work for you. (See notes below) That tells you the annual payment on a loan for a repayment mortgage of a given number of years.

So for a £100,000 loan (as an example) and 25 years, this is how the annual payment varies with interest rate, very quickly calculated with that excel formula. (Your payments might be slightly different due to timing issues - seen notes below.)

2.0% £5,122
3.0% £5,743
4.0% £6,401
5.0% £7,095
6.0% £7,823
7.0% £8,581
8.0% £9,368

Deciding how much is interest and how much is repayment is based on working out what declining balance of the loan would result in the same payment for the remaining period of the loan. So, for example, at 4%, to get a £6,401 payment on a 10 year loan would imply a loan amount of £51,919. So that means you have paid off £48,081 after 15 years. But at 7%, to get a £8,581 payment on a 10 year load would imply a loan amount of £60,270. So you have only paid off £39,730 after 15 years at 7%.

Notes on the Excel formula. The formula operates on the assumption of a particular timing of the payment in the payment period, which you can control with an additional parameter. But if you just divide the payment by 12, it won't be exactly the payment for a monthly payment, because the exact timings won't match what happens with a single payment. If you want to calculate a more accurate monthly payment, you need to use the formula as follows =PMT (Monthly interest rate, Months, Loan). To calculate the monthly interest rate from annual rate, use this formula: Monthly interest rate = (1 + R)^(1/12) - 1 Where R is the annual interest rate. In fact many loan providers, in these days of computers, calculate the daily interest payment using a daily interest rate, so you have a daily charge thus: =PMT(Daily interest rate, Days, Loan). They will then add up the daily interest payments up over a month and charge you that on some date in the month. Or charge you 365/12 daily charges, to even out the monthly payments. The daily interest rate is (1+R)^(1/365)-1. You will also observe the formula produces an -ve answer consistent with accounting principles, which I have suppressed above.

Each month, my mortgage statement comes through telling me how much went to reduce the principal, what the remaining principal is, and how much went to interest - which is what I'm basing my rough estimate off of. Your calculation is how that assignment is arrived at.

That assignment is vital in a changing interest rate scenario (whether due to variable rates, or refinancing), as it determines the principal that the interest is recalculated on at the change.

Your calculation here gives pretty much the same answer as my rough estimate, by the way.

[lpm]

Every mortgage applicant (in the UK) gets a sensitivity analysis. The mortgage offer will say something like "if the interest rate rise to X your repayments will be Y".

Adults should be given info like this and then left to their own decisions.

[dyqik]

Every mortgage applicant (in the UK) gets a sensitivity analysis. The mortgage offer will say something like "if the interest rate rise to X your repayments will be Y".

Adults should be given info like this and then left to their own decisions.

I feel like it's good to teach people how to do the calculations and to have an intuitive feel, as well as giving them specific examples.

What range do those sensitivity examples have to cover? Because if it's only something like the past five or ten years historic range, some people are going to get a nasty surprise.

[IvanV]

That assignment [principal remaining] is vital in a changing interest rate scenario (whether due to variable rates, or refinancing), as it determines the principal that the interest is recalculated on at the change.

Correct.

Your calculation here gives pretty much the same answer as my rough estimate, by the way.

But it won't be quite right, because it will fail to take in account of the change in the curve of principal repayment. That will be a small error for more modest changes in the interest rate, and the error will grow for larger changes.

Approximations are fair enough when doing it properly is too much like hard work. I was trying to persuade you that doing it (more nearly) properly is actually quite easy, and helps with the general understanding of how these things work.

[dyqik]

That assignment [principal remaining] is vital in a changing interest rate scenario (whether due to variable rates, or refinancing), as it determines the principal that the interest is recalculated on at the change.

Correct.

Your calculation here gives pretty much the same answer as my rough estimate, by the way.

But it won't be quite right, because it will fail to take in account of the change in the curve of principal repayment. That will be a small error for more modest changes in the interest rate, and the error will grow for larger changes.

Approximations are fair enough when doing it properly is too much like hard work. I was trying to persuade you that doing it (more nearly) properly is actually quite easy, and helps with the general understanding of how these things work.

I know exactly how to do it properly - I am a physicist who has to do this kind of calculation all the time. But since I don't know what the change in interest rate will actually be, there was no real reason to do it properly - because the uncertainties in what the interest rates will be or are starting from give greater ranges than the difference between the estimate I can do in my head and the full calculation. The full calculation is no more accurate if you aren't sure of the inputs.

[wilsontown]

When I got my mortgage about a year and a half ago, there was a single illustrative example in the mortgage offer letter of what the monthly payment might rise to if the interest rate were 9.49%. I'm not sure why they chose that particular number. Luckily the interest rate is fixed for another three and a half years but who knows what the situation will look like then...

[El Pollo Diablo]

When I got my mortgage about a year and a half ago, there was a single illustrative example in the mortgage offer letter of what the monthly payment might rise to if the interest rate were 9.49%. I'm not sure why they chose that particular number. Luckily the interest rate is fixed for another three and a half years but who knows what the situation will look like then...

[dyqik]

When I got my mortgage about a year and a half ago, there was a single illustrative example in the mortgage offer letter of what the monthly payment might rise to if the interest rate were 9.49%. I'm not sure why they chose that particular number. Luckily the interest rate is fixed for another three and a half years but who knows what the situation will look like then...

*pic*

I would have gone with the burning M25 from Good Omens.

[gosling]

I got my first mortgage back in the early 90s when they were still trying to flog endowments. The broker showed me how much money I would get at the end with 10% interest rates. I asked him to model 5% and 3%. "Oh, they won't go that low," he said. The figures showed I'd owe almost as much as I'd initially borrowed at the end of the 25 years. I stuck with a repayment mortgage.