Monday, April 25, 2016 / by Nicole Solari
The Fed was planning to raise interest rates four times in 2016. They're now saying it will only be twice. What few people fail to realize is how seemingly small mortgage rate increases can result in a huge amount of additional interest over the life of the loan. To illustrate this point, if your first-time buyers obtained a $200,000 mortgage and the rate increased from 4 percent to 5 percent, your first-time buyers would pay $42,772 (21.4 percent) more in additional interest. If the rate increases from 4 percent to 6 percent, your buyers would pay an additional $87,937 in interest -- a whopping 44 percent of the initial loan amount.
On a $200,000 loan, the total interest for a 30-year mortgage at 4 percent is $164,814 versus $231,577 for a 40-year mortgage. That’s a difference of $66,763 that could be put toward the owners’ retirement, a college education for their children or a host of other needs. If mortgage rates stay above zero, it makes sense to pay off your mortgage more quickly rather than stretching out the payments.
When interest rates go negative, the banks charge other banks (and sometimes their retail customers as well) for leaving their money on deposit. A negative interest rate of 1 percent would mean for every $100 you had on deposit, you would lose $1 the first year, then an additional 1 percent of the amount for every subsequent year. Denmark, Japan, Sweden and Switzerland currently have negative interest rates. Central banks in other countries are looking at this strategy as well. Their goals are twofold. First, to defend their currency and second, to stimulate spending, create more jobs and increase inflation. When a currency becomes too strong, as the dollar has done recently, products from other countries are cheaper. Conversely, when a currency is weak, that country has less international buying power, but their exports are cheaper. This improves their balance of trade.
Denmark’s move into negative interest rate territory illustrates how strange the negative interest rate environment can be. Denmark’s interest rates did help it to defend its currency, but rather than stimulating jobs and spending, Copenhagen is now facing its second real estate bubble since 2008. Here’s what was really surprising, though: when the interest rate on certain adjustable rate mortgages dipped below zero, some lucky borrowers had a brief period where the bank paid them.
Real estate has inflationary and deflationary cycles. What we have never experienced in our lifetimes is a deflationary cycle coupled with negative interest rates. In a deflationary cycle where prices are falling across the board, it’s better to delay purchasing as long as possible. Furthermore, if interest rates dip below zero, your money is worth more in your wallet or under your mattress.
Nicole Solari RE/MAX Gold The Solari Team