Choices for those hit by mortgage rate rises
The offers are already being made to people facing big mortgage interest rises. “If your lender won’t renegotiate, we’ve got deals that will lower your payments,” they say. Are these deals any good?
One of the top rules in personal finance is: Never get into a position in which you are forced to sell, as you’re likely to settle for a low price. So, if higher mortgage interest finds you contemplating selling, it’s certainly worth checking your options.
One, of course, is to reduce your spending. Another is to take in a boarder or two. But if they won’t work, there are three ways to reduce your mortgage payments:
Pay interest only for a while.
This makes little difference in the first few years of your mortgage, as most of your payments go on interest anyway. But if you have had the loan for, say, ten years or more, the drop will be noticeable.
The obvious downside is that you stop paying off the property.
Note, too, that over the long term the payments aren’t all that different.
For example, payments on a $200,000 10 per cent interest-only mortgage are $1,667 a month, versus $1,755 on a 30-year principal-and-interest loan. And with the latter, you end up with a mortgage-free house.
Pay lower-than-market interest, and “capitalise” the rest of the interest — adding that money to the loan balance.
Let’s say you have a $200,000 principal-and-interest mortgage and the interest rate has just risen to 10 per cent, so you are paying $1,755 a month.
A lender might let you go back to your old 8 per cent — or if you are a landlord, perhaps to the 5 per cent rental yield on the property.
At 8 per cent, your monthly payments will drop to $1,468 — close to $300 less a month. And at 5 per cent, the payments will drop hugely, to $1,074.
But — and this is a big “but” — your debt will be growing at a compounding rate. A lender is likely to go along with it only if you have considerable equity — which means your house value is well above your mortgage.
Even so, with the strong possibility of house values falling, you want to be confident you mortgage won’t grow to more than your house is worth. Because of that potential, I like this option least.
Lengthen the term of your loan.
This can make quite a difference to payments without increasing the loan. If a $200,000, 10 per cent mortgage runs for 20 years, monthly payments are $1,930. At 30 years, they are $1,755; and at 40 years they are $1,698.
The negatives this time are that you’re stuck with a mortgage for longer, and you end up paying way more interest. On the 20-year loan, your interest would total $263,000. On the 30-year loan it would total $432,000 and on the 40-year loan, $615,000.
Double the term and you almost triple the interest. And those hundreds of thousands of dollars are real money that you could have had to spend in retirement.
Conclusion
None of the options is great. If you take one, please do your best to get back to the old payment level as soon as possible. Just as repaying your mortgage fast is a great use of your money, delaying repayments is a great waste of your money.
But if it’s that or be forced to sell your home in an increasingly unattractive market, the first or third options are worth considering for a while. Mortgage brokers should have information on who offers what.
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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.