#6 - Why Mortgage Rates Matter So Much
Why does such a small change in interest rate have such impact?
Irish mortgage interest rates are the second highest in Europe. This is clearly bad - the interest rate is the ‘cost’ of a mortgage and it’s never good to pay the second highest in Europe for anything. But just how impactful is this? Can a one percent difference (say, 2.5% v’s 3.5%) really make much difference…
First, a few facts about mortgages:
You borrow a large amount, and pay it back monthly over a long time.
Interest accrues (i.e. adds up) constantly, so every repayment must first clear the interest accrued over the previous month before it can reduce the balance.
Since homes are expensive and mortgages are high, the amount needed to keep the interest paid is actually quite a lot. A €250k mortgage at 3.5% over 30 years needs €8,750 per year (€729 per month) just to pay the interest. Let’s repeat that for emphasis - €8,750 a year just to stand still!
So in the first few years you make very little impact on the balance. You could easily make €50k of repayments over five years yet only reduce the balance by €10k.
But as time goes on the balance reduces, interest accrual slows down, and more of each payment goes to reducing the amount you owe. It’s like a treadmill that gradually slows down.
The interest rate affects how quickly all of this happens. Not lets look in more detail with a €250k mortgage over 30 years:
At 3.5% interest, monthly payments are €1,122 and you will repay a total of €404k over the life of the mortgage - €154k in interest and €250k in principle.
At 2.5%, you’ll pay €988 per month and €356k in total - €106k in interest and €250k in principle. That 1.0% change in interest rate saves €134 per month and a whopping €48k in interest over the life of the mortgage.
Now take it a step further - imagine keeping up the payments in the first scenario (€1,122) but with the 2.5% interest rate in the second. This would shorten the life of your mortgage to 25 years and reduce total interest paid to €86k.
To spell that out, a 1.0% reduction in interest rate could knock 5 years off your mortgage and save €68k in interest. That’s got to be one of the best financial decisions you can make. There’s nothing you can do about our interest rates being the second highest in Europe, but you sure as heck can ensure your mortgage is on the best available rate in Ireland!
We’ve built an online calculator to calculate the savings for your individual circumstances. It’s free, easy to use, and can be accessed here. I hope it might encourage you to re-examine your existing mortgage.
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