Another reason why you need an amortization schedule
There are two options before you as you deliberate renewing your mortgage, a 10 year 3.84% interest rate or a 5 year 3.14% interest rate. Should you lock in at 3.84% for ten years, for peace of mind, or take the lower five year rate of 3.14% and hope five years down the road the 5 year term rates are the same or lower?
Assume you take the five year term rate of 3.14%. How high would the five year term interest rates have to be five years from now to make it the same as if you took the ten year term rate of 3.84%?
Quick Answer:
4.85%
Detailed Answer:
Three amortization schedules were required.
You would also require amortization software that allowed you to calculate any one of the missing variables in a mortgage (3 out of 4 calculation feature). Here is the step by step procedure used.
The average price of a house in January of 2012 in Canada just reached the $348,000. A 25 year amortization period was chosen and the interest rate is 3.84%. The monthly payment was selected to be an even $1,800 thus the Principal was recalculated to be $347,904.96 (this required the 3 out of 4 calculation feature).
After 10 years of $1800 per month payments at 3.84% the total interest paid would be $114,608.
After 5 years of $1800 per month payments at 3.14% the total interest paid would be $49,931 and the balance owing is $289,836.24
So that leaves only $64,677 in interest that can be paid in the second 5 year term if the two 5 year terms are to extract the same interest as the 10 year term (114,608 – 49,931 = 64,677).
By playing the “what if” game with the 3 out of 4 feature (starting with a rate of 3.14%) the rate in the CALCULATOR was increased and the Amortization Period was recalculated until the accumulated interest in the SPREADSHEET came close to $64,677.
CONCLUSION:
If the rate for the second 5 year term is 4.85% then it is the same as if the initial mortgage was taken out for the 10 year term. If the second 5 year rate is lower than the 4.85% the borrower wins by saving more in interest costs. If the second 5 year rate is higher than 4.85% the borrower loses and ends up paying more interest than the 10 year term at 3.84%.
Looking at long term Bank of Canada rates might help you decide if a 1.71% percentage point increase is probable over a five year period (4.85 – 3.14 = 1.71).