If I was to ask you, what interest rate is being charged to your mortgage, would you know the answer?
I hope you do, because a mortgage, for most of us, is probably the biggest debt we will ever take on in our lifetime. And is therefore the one we will pay back the most in interest payments. So, it was very surprising to learn that following a survey carried out recently by the Competition and Consumer Protection Commission (CCPC) it found that only 52% of respondents claimed to know what interest rate was being charged on their mortgage.
The CCPC however, did uncover that 82% of those surveyed knew what their monthly repayment was. And I am assuming the percentage is higher in this regard because they can see what amount is being debited from their current account each month.
If we know what our monthly repayment is, then do we really need to know what interest rate our mortgage is being charged at? And is it OK for those who don’t, to continue to ignore it? And before I answer these questions, let me tell you first about the four things that matter most when it comes to your mortgage and yes you guessed it, one of them is the interest rate.
All four are: The amount you borrow; the rate of interest; the term of your mortgage; and your monthly repayment
All four have an impact on the total amount of interest you will end up paying, and all four are things you can control and change, and here is the important thing to know - if you can change one, it will have an impact on the others. For example, if you can reduce the interest rate, the knock on effect is that, a) your monthly repayment will go down and, b) the total amount of interest you repay will also reduce. If, for example you borrowed €200,000 over 25 years at an interest rate of 4%, your monthly repayment will be €1,056 and the total amount of interest you repay, €116,702. If you reduce the interest rate by 0.5% then your monthly repayment will reduce to €1,001 and your interest payments to €100,374. In this instance, the impact of lowering your rate reduces two things; your monthly repayment by €55 and your total interest payments by €16,328. Let’s make another change, what if you alter your monthly repayment, and increase the amount you repay each month, then again two things will happen, a) the term of your mortgage will reduce and, b) the amount you repay in interest will, as a consequence decrease as well. Staying with the same loan amount and term as outline already, if you were to increase your monthly repayment by €157, now your term has reduced by 5 years, and the amount of interest you pay back to your lender drops by c. €25,888.
Here’s another one, rather than starting out with a 30 year mortgage, what if you decided to repay it over 20 years instead? Yes, your monthly repayment will be bigger, but the amount you could end up saving, depending on the amount you borrow, enormous.
If for example you borrowed €200,000 and you chose to repay it over 25 years instead of 30, you would pay €101 extra every month but save a total of €27,037 in interest payments.
I understand that it may be hard to find that extra money each month, and it’s easier from a cash flow perspective to take the easy option and take out a longer term, but I have come across people who challenge themselves with a shorter term, and you know what, they get used to their monthly repayment and adjust their budget accordingly and the difference in someone saying, there is 12 years remaining on their mortgage instead of 22 is huge, all because they didn’t take the easy route. And the options it gives them, only confirms that the hard work was worth it, because they can retire earlier because their mortgage is repaid, or they can work for a lower salary and work at a slower pace, all because they don’t have to make an additional 120 monthly mortgage repayments.
I have said it before and will repeat it again, the lending industry has in my opinion succeeded in doing two things, the first is dictating how long a person can have a mortgage for and the second reason is influenced by the first, and that is getting borrowers to focus on monthly repayments, which become smaller the longer you have a mortgage for, and this avoids the borrower having to look or be concerned about the total amount they will repay them. And this might explain why, according to the CCPC that only 15% of mortgage holders have considered switching their mortgage in the past five years, with the majority of those asked why not, saying they didn’t think it was worth their while.
It has been proven in countless studies that we make judgements like this, when we view the saving as a proportion of the total amount we repay each month, and this is known as relative thinking. We also factor into our thinking not just the financial saving but the value of our time, and if the effort is big, we are committing ourselves to future work which involves getting the house re-valued, completing application forms, gathering bank statements which is all a bit of a pain. But if we front loaded the saving i.e. the total amount of interest we would save, and it was given to us when we changed providers, would we mind getting salary certs completed then? Don’t think so.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at firstname.lastname@example.org or www.harmonics.ie