Example scenario
Loan amount – 500K, loan period – 20 yrs
Interest rate original / hike – 1% / 5%
Monthly payment original / increase – 2.3K / 3.3K
That is a 30 percent increase in monthly loan payments for a 4 percent rate increase.
Why?
Calculated using online calculator
In: 0
Depends on where you’re at in your mortgage payments. The early payments of a mortgage are almost all interest and no principle. A raise in interest rate at this point is going to significantly affect the payment amount since you now owe more in intrest in the same amount of payments.
This is why you shouldn’t ever get an adjustable rate mortgage.
If the interest rate goes from 1% to 5%, that’s a 400% increase in interest rate (the rate is now 5x what it was before). The reason your payment doesn’t quintuple is that some of your payment goes to principal and not to interest.
It’s 5% *per year.* If you borrow money for 20 years, some of the money you begin paying back right away, but some of the money you’re paying 5% interest per year for 20 years. And interest compounds… so 5% for two years isn’t 10%, it’s 10.25%. And 5% for 20 years isn’t 100%, it’s 265%.
Depends where you’re located. In the US, the vast majority of mortgages are fixed rate 15 or 30 year loans, so existing loans aren’t impacted by rate increases.
But, yes 4% increase in interest rate could cause a 50% payment increase because the way loans are amortized, that 4% is applied per year to the remaining balance for the remaining years.
It’s a 30% increase for a 4 ***percentage point*** increase. Percentage points are not the same as a raw percent increase. In terms of percent increase, it’s a 30% increase for a 400% increase in rate.
The percentage rate is what percentage of the loan is due that year. So if it is a $100,000 loan a 1% interest rate means you owe $1,000 a year. If it’s a 5% interest rate, you owe $5,000 a year. So the difference is $4,000, or about $333/month.
Technically it’s recalculated every month so you owe 1/12 of whatever the interest rate is of the remaining balance of the loan. But the idea is the same. They use an amortization calculator to make it so your total monthly payment will pay off the loan plus interest in the given number of years.
Since this 5yo seems to know percentages, the amount you actually end up paying over the 20 years, times the loaned amount is f = r*(1+r)^240 / ((1+r)^240- 1), where r is 5% / 12 (the monthly rate).
(ELI>5) This can be found with some algebra, but ultimately follows from the formula for a “geometric series.” One intuition is to imagine how much each payment saves you in interest: the first month’s payment effectively saves you payment * (1+r)^239 over the lifetime of the loan, the second month’s payment effectively saves you payment * (1+r)^238 over the lifetime of the loan, and the last payment, when you will just owe p, will save you p*(1+r). When the amount your payments “save you” equals the amount you would pay otherwise, you can solve for the payment.
Anyway, plugging into the formula, you get that 5% leads to a 43.502% higher payment than 1%, and indeed 2300*1.43502 = 3300 and change.
[Source](https://www.wolframalpha.com/input?i=Solve+f%28.05%2F12%29%2Ff%28.01%2F12%29+for+f%28r%29+%3D+r*%281%2Br%29%5EM+%2F+%28%281%2Br%29%5EM+-+1%29+where+M+%3D+240)
It’s caused by the compounding nature of interest over the term of the loan. An interest rate increase means everytime the interest compounds you owe more on the principal you borrowed, but also more on the interest earned during the compounding periods. The more compounding periods remaining the greater the effect. How a mortgage is structured can also have an impact, but for simplicity sake the route cause is compounding intrest.
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