How do interest rates effect loan payments?
- In the first field, enter the amount to borrow.
- In the second field, enter the number of years to pay back the loan.
- In the third field, enter an annual percentage rate for the interest.
- In the fourth field, enter a second annual percentage rate for the interest.
- Click the "Compute" button and you will see: the monthly payment for financing a loan with first interest rate, the monthly payment for financing a loan with the second interest rate, and the difference between the two options.
Comparing Auto and Home Loans
by Joseph Ganem
Many people with adjustable rate mortgages have been forced into foreclosure when their rates reset. These types of mortgages usually have a below market interest rate in the beginning that is then adjusted a year or two later on. The idea is to have lowest possible monthly payment in the beginning so that the buyer “qualifies” for the most expensive house possible. Later, when the monthly payments adjust to something unaffordable, the mortgage broker and loan originator will be gone having taken their fees with them. The homeowner and mortgage holder will be left with the problem of how to make the payments.
Adjustable rate loans do have legitimate uses and can be a good idea when properly understood. The important point is that the homebuyer must know and be prepared for the inevitable rise in monthly payments. Numbers fool many people because the difference between 4% and 6% doesn’t sound like much, but with mortgage math it can amount to thousands of dollars per year.
The important point in understanding loans is that the longer the term the greater impact a small change in the interest rate has on the monthly payments. If you are comparing 4-year car loans, the difference between 4% and 6% is not great. The calculator on the left can show that for a $20,000 auto loan the monthly payments over 4 years are about $452 at 4% and $470 at 6%—a difference of $18 per month. But, structure these same loans over 30 years and the difference between monthly payments of $120 and $95.50 is $24.50 per month. Because homes typically cost 10 times more than cars, this becomes an increase of $245 per month for a $200,000 mortgage. That amount—almost $3000 per year—will be noticed in any family’s budget.
To make matters more confusing, 2% increases are not all created equal in terms of actual dollars. On a $200,000 30-year mortgage, adjusting from 4% to 6% adds $245 per month, but going from 6% to 8% adds another $268 per month, and a change from 8% to 10% adds another $287 per month. As the rates increase, each 2% change adds a greater amount to the total monthly payment. That means the difference between a 4% teaser rate adjusted to a 10% subprime rate is $800 per month for a $200,000 mortgage.Before you agree to an auto loan or home mortgage, shop around and use the calculator on the left to compare monthly payments for different interest rates. If agree to an adjustable rate mortgage plan your budget for the future, not the present.
Joseph Ganem is author of the award-winning book: The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy. Hear him talk about the book below.