It is tempting to choose an interest rate close to or below 0% rather than an interest rate of 2%. Still, many are in doubt, and that is, of course, because everyone knows that there are risks associated with choosing a variable rate instead of a fixed rate.
There is no doubt that the benefit of variable interest is a lower benefit here and now. And as an extra gain, you pay off more on your debt. The latter, however, means that after-tax benefit savings are not as great as interest-rate savings. This is also because the contribution rate is significantly higher on a variable rate loan.
You can see the difference between different loans
You get the biggest savings in the net benefit with an F-Card, where the benefit is USD 954 lower per. and at the same time you pay an extra USD 2,170 per month. month. On the other hand, you only know the interest rate for 6 months, and thus both benefits and installments.
How do interest rate increases affect performance ?
The performance of a loan consists of interest, repayments and contributions. When interest rates or contributions increase, so does the benefit. But when interest rates rise, then the repayment decreases. Therefore, if you have a variable rate loan, you save less when the interest rate rises.
The calculations below show the changes if the interest rate increase occurs on the next interest rate adjustment, ie after 3 and 5 years for F3 and F5 loans respectively. For F-Cards, the changes happen after 1 year.
One thing is the increase in benefits, but what about the free value?
How do interest rate increases affect debt ?
The above calculations were for a debt of 3 million, which represents 80% of the property value, ie USD 3,750,000.
The fair value is the difference between the value of the property and the value of the loan. We can therefore count on what it will cost to repay the 4 loans when interest rates have increased. In the calculations, we take into account both the amount of the repayments on the loans and how much is saved on benefits after tax. The savings, we assume, are saved.
And of course, we take into account the significant advantage of choosing a fixed rate loan.
When the interest rate rises, the redemption price and thus the price value also fall.
This benefit is not available with variable interest loans. Here you only get a higher performance.
As a rule, interest rate increases also adversely affect property value, but there may be other factors that go the opposite way. But the property value is the same no matter what financing you choose. Therefore, it is more important to look at the market value of the debt than at the fair value, which in this case only shows the difference in the market value and the accumulated savings / extra payments on the loans.
What to choose?
In the first half of 2018, 37% of homeowners opted for a variable rate loan. The figure is strongly downward. In 2016 and 2017, the share was up 45%. Whether the increase is due to fears of rising interest rates or the fact that the rates of contribution on variable rate loans are significantly higher is hard to say.
We can see a picture showing that many homeowners want to exchange their variable-rate loans for fixed-rate loans. However, we can also see that many do not anyway. Probably because they think the increase in benefits is too great. They therefore choose a short-term assessment of their financing.
Others choose a longer -term assessment , which takes into account that variable-rate loans will at some point become more expensive and have the opportunity to reduce their debt when converting fixed-rate loans.
The short-term assessment in the example is that it is preferable that the net benefit is up to USD 468 lower per month on a debt of USD 3 million, or that here and now you pay off up to an extra USD 2,270 a month. This is faced with the long-term assessment, where a rise in interest rates can reduce the value of the debt by USD 212,000 – 581,000 if the interest rate increases by 1% or 3% respectively.