Seeing the Cat

Here’s the second in a series of posts about mortgages. The first, about fixed rate mortgages, is here.

I ran a spreadsheet that looks at the effect of a 2% increase in mortgage rates. It assumes a 30 year term, principal of $100,000, and a range of mortgage starting rates from 3.5% to 6.5%, which adjust up by 2% at the end of the first year. Here are a few factoids:

1. Monthly Principal and interest payment per $100,000 of principal:

• At 3.5%, $449
• At 5.0%, $537
• At 6.5%, $632

2. Allocation of First Payment:

• At 3.5%, 35% of one’s first mortgage payment is principal; 65% is interest. ($157 principal and $292 interest)
• At 5.0%, 22% is principal, 78% is interest. ($120 and $416)
• At 6.5%, 14% is principal and 86% is interest. ($90 and $541)

3. Allocation of Twelfth Payment:

• At 3.5%, 36% of one’s 12th payment is principal
• At 5.0%, 24% of one’s 12th payment is principal
• At 6.5%, 15% of one’s 12th payment is principal

4. After one year, the balance on a $100,000 mortgage is

• At 3.5%, $98,081 (1.9% paid off)
• At 5.0%, $98,525 (1.5% paid off)
• At 6.5%, $98,882 (1.1% paid off)

5. After one year, the rate adjusts upward by 2%. The new monthly payment, amortizing over 29 years, is

• At 5.5%, $565
• At 7.0%, $662
• At 8.5%, $776

6. The new monthly payment as a percent of the original payment is

• At 5.5%, 126%
• At 7.0%, 123%
• At 8.5%, 121%

7. Interest has risen, from the 12th payment to the 13th, by

• At 5.5%, 57%
• At 7.0%, 40%
• At 8.5%, 31%

8. The monthly principal payment has fallen, from the 12th payment to the 13th, by

• At 5.5%, 29%
• At 7.0%, 30%
• At 8.5%, 32%

9. Allocation of 13th payment:

• At 5.5%, 20% of the 13th payment is principal, 80% is interest ($115 principal and $450 interest)
• At 7.0%, 13% of the 13th payment is principal, 87% is interest ($ 87 and $575)
• At 8.5%, 9% of the 13th payment is principal, 91% is interest ($ 66 and $700)

10. Allocation of 24th payment:

• At 5.5%, 21% of the 24th payment is principal, 79% is interest ($121 principal and $444 interest)
• At 7.0%, 14% of the 24th payment is principal, 86% is interest ($ 93 and $569)
• At 8.5%, 9% of the 24th payment is principal, 91% is interest ($ 71 and $695)

Some observations:

1. People who at 6% interest rates might be renters might rationally choose to become homeowners at 4%, particularly if told by a real estate agent they think is representing their interests, or a mortgage broker who wants to make a sale, that rates probably won’t rise. [And the Realtors’ ads would certainly give the potential buyer the impression that “their” real estate agent is working for them. A first-time homebuyer, particularly a first-generation homebuyer, wouldn’t be able to parse the truth of the message of those ads. Among other places, I’ve heard these ads on stations targeted to minorities, and aimed at first-time buyers.]

Note to first time buyers: 1. “Your broker” does not work for you. S/he works for the seller, and is paid by the seller to make the deal close, not to represent you or protect your interests, or even to give you good advice. 2. “Your” broker is paid by the seller, and only gets paid when the deal closes.

2. A 2% increase in the mortgage interest rate (from 3.5% to 5.5%) increases the lender’s take by 57% and reduces the monthly paydown of principal by 29%. A 2% increase from 5.0% to 7.0% increases the lender’s take by 40%, and reduces the monthly paydown by 30%; a 2% increase from 6.5% to 8.5% increases the lender’s take by 31% and reduces the monthly paydown of principal by 32%.

3. Refinancing that mortgage into a fixed rate causes the borrower to repeat the first year of payments, when a large majority of the payment goes to paying interest.

4. Refinancing a mortgage moves one from being in, say, the 3rd year of a 30 year mortgage to being, effectively in the 3rd year of a 33 year mortgage. That is, the payoff date has been pushed out.

5. Purchasing a move-up home has many of the qualities of refinancing the mortgage on the first home.