Today, the repo rate is very low and it makes it clear that all interest rates for loans, savings rates, etc. are also very low. For those who have a mortgage, it will definitely be cheap.
What you should not forget is that this is an unusually low interest rate and the current interest rates do not last forever. Many people have worse margins than what is really good and would manage a low-interest rate hike. How’s that for you?
With a negative repo rate and a mortgage rate that is somewhere around 1.65%, it is cheap to have a mortgage. If you had a mortgage loan of about USD 3,500,000 and a loan-to-value ratio of 85% (which is a maximum) it would mean that you have a mortgage loan of USD 2,975,000. With the low interest rate, this will only be around USD 4,100 a month in interest expense.
Most people can handle it
Although it has felt very stable with low interest rates now for a number of years and it also seems to be able to last for one or a couple of years, the truth is that sooner or later there will be a rise in interest rates. When inflation accelerates and the repo rate increases, there will be higher mortgage rates and other interest rates will rise as well. Expecting an interest rate of 5% and even more than that is not at all strange.
If the interest rate were to rise 4% from the current level, it would mean a rather large difference in interest costs for many households. If we take my example with a mortgage loan of USD 2,975,000, then the interest cost would then be at USD 14,000 instead of just over USD 4,000 a month. It is an increase of almost USD 10,000 a month that must fit in your budget. How many people out there actually have USD 10,000 extra to put on the mortgage each month?
Many who would have problems with a higher interest rate
Recently, I read an article that discussed just this to get is really ready for a higher interest rate. It has become everyday with a really low interest rate and people have become accustomed to this being standard. But it was not so long ago that the interest rate was 4%, as it did in 2012.
The article states that there are many, especially younger ones, who would have trouble coping with a 3% interest rate increase, which is less than I expected in my examples above. If the interest rate went up by 3%, it would end up at about 4.65% and this is clearly an interest rate that can become relevant within five years, depending on how inflation and the like develop.
As many as 36% of those surveyed said they would be forced to change their lifestyle and spend if interest rates rose by 3%. People would then be allowed to make changes in their standard of living and, for example, reduce holidays and entertainment, etc. A few percent say they would be forced to sell their home, but we also have a small dark figure of 11% who say they do not know how they would manage if interest rates rose by 3%.
It is the younger ones who, above all, would have problems. They have greater requirements regarding mortgage repayments and the like, while they may have bought housing in an expensive housing market and have large loans. Perhaps even the low interest rates have attracted them to buy housing that is really a little too expensive for their finances. In the 20-40 age group, only 47% say they have sufficient margins to handle an increase in interest rates of this size.
The older people do not have as big a problem as the young ones. They have better margins and probably smaller loans, so it will not be as effective when interest rates go up. 64% of the elderly say they can handle an interest rate increase without any direct changes in their finances. However, this figure is lower this year than last year.
Something else that was asked about in the survey was about margins and there it seems that people have larger margins and that it has increased in recent years. However, it looks worse when it comes to how well one would manage to raise the interest rate.
Ways to prevent problems
There are of course many different ways to prevent these problems and I was going to go through some more basic good things for anyone who wants to avoid having problems with raised mortgage rates here.
Always expect an interest rate of at least 5 percent
The interest rate level we have now is not normal and it will go up over time. If 5% interest rate sounds great, this can be compared to times when we had around 15% interest rate. It wasn’t that long ago, really. Getting around 5% is not strange at all.
Since it can actually be considered normal to have an interest rate of around 5%, it is smart to always think that you should pass an interest rate at this level. This means, first of all, that when you are looking at buying a home, you should not only make a calculation to see what your monthly cost with amortization and interest expense would be at the current interest rate level, but you should also put in extra so you can see what it would have an interest rate of 5%.
You can then see if the household would still be able to buy the current home and be able to afford to pay every month. If you notice that it is still within the limits of what you can manage (although it may of course be slightly worse margins) then it is ok. Otherwise, you may want to check out a cheaper house or condominium with a lower fee, etc.
Another thing you can do if you count on 5% is that you can simply take the difference between what you have to pay in interest now and what you would have to pay in interest if the interest level was around 5% and simply put away the money on a savings account. That money forms a buffer that can then be used just to help your personal finances the day the interest rate actually reaches such a high level. Then you have thought ahead and are clearly safer.
Pay on the mortgage
Such a simple thing as amortizing on your mortgage can make a difference when interest rates start to rise. Right now, the difference in interest expense per month is minimal whether you amortize or not, but the day when the interest rate becomes high, the difference will of course also be larger.
The less you have left of your mortgage, the less amount you have to pay interest on. When the interest rate is low, it is not so that you notice this very much, but for every percentage that the interest rate rises you will also notice it more and more. If you have been good and amortized on your mortgage all the time while the interest rate was low, you will get it again later.
Since the amortization requirement was introduced, many people are forced to amortize, whether they want to or not, but everyone who sits on homes bought before the requirement came into effect on June 1 has the opportunity to control this themselves. It is a good idea to pay off your mortgage. It is not a cost but an investment in your future finances.
Do not forget about top loans and the like
One thing to remember is that it is not only the large mortgage loan that is affected when interest rates go up. Admittedly, a top loan usually does not have the same maturity, but it can still be that you take out a top loan when the interest rate is low and then it goes up while you have your loan remaining.
The top loan may not be huge, but it is much more expensive from the beginning because you have no security for this part. It’s like a regular private loan. If you manage to get around 1.65% interest on your mortgage, the top loan can still have an interest rate of, say, 6% or more. If we take the same example as before and expect a top loan of 10%, it would be a loan of USD 350,000.
This loan, with an interest rate of 6% (which is the low interest rate we have today) would cost about USD 1,750 in monthly costs. It can differ in monthly costs depending on the maturity of your top loan. If the interest rate goes up by 4% from the current level, the new interest rate for this type of loan would be 10% and then the monthly cost would be around USD 2,900 instead. This is an increase of approximately USD 1,150.
You can therefore add an additional USD 1,150 a month for this loan in addition to the large increase in interest expense for the mortgage loan. If you then have any additional loans, you can expect interest rates to rise for them as well. It can be a loan for cash, which is also part of a loan for housing, but it can also be a completely different loan. All loans with variable interest rates are affected.
Tie parts of the mortgage
An alternative that may be interesting is to tie up parts of their mortgage. Variable interest rates have historically been the cheapest and you should not abandon the variable interest rates. What you can do is to tie one or more parts of your mortgage with different maturities. In this way, you can fix the interest rate at a level that you think is ok and which you can afford for parts of the loan.
The point of tying up parts is that you can still use the (usually) slightly cheaper floating interest rate, but at the same time you can make sure that the interest rate does not increase very much and that you then get too high costs. You have better control over what your monthly costs will look like in the next few years and avoid the biggest crunches in the event of major interest rate hikes.
What you should keep in mind is that it will be a little harder to settle a mortgage if you have tied up parts of it. You can’t just change bank anyway. It should also be borne in mind that you do not unnecessarily tie up the loan. Today, fixing the interest rate for a couple of years is probably not particularly smart since the interest rate is still expected to be low for another couple of years. If you are to fix the interest rate today, it can probably be interesting in the longer term.
How do you best manage from a higher interest rate?
In order to have the best protection against rising interest rates, you must use a combination of all the tips that I have included in this post. First, you should try to find a home that is not too expensive for your budget. Then, as I said, you should not only calculate how much it would cost today but also how much it costs with an interest rate around 5% or more.
You should make sure that you have margins in your finances even after you add the cost of the new home. It should not be that it just goes around, but there should be room for extra costs and interest rate hikes etc. The better the margins, the safer you are.
You can also save money on a special interest buffer account as long as the interest rate is low. You can save that money now considering that hopefully you have included in your finances that you can afford a higher interest rate and then you can put away some money to have as extra security and help when it becomes relevant with high interest.
Pay off the mortgage even if you don’t need to. It is noticeable now but it pays off later when interest rates rise. You can use some of the money that you get in your budget now that interest rates are so low to put down payments on your mortgage. This way you invest in your own finances and get a cheaper mortgage in the future.
Perhaps most important is that you always take the safe before the uncertain. Count a little higher than you think on all expenses and if you are unsure of something then it is better to go for a little extra instead of pulling in the cheap way. If you are wrong, it is clearly much nicer to have calculated too high and get extra money over than to have calculated low and get higher costs than expected.