# How Do Interest Rates Affect Mortgage Payments?

December 31, 2013 QUESTION

It depends.

Mortgage rates can really be almost anything. Rates were seen at over 20% for a short while in the 1980s and have been as low as a couple of percent for variable rate mortgages in the late 2000s. But lets look at rates around 4% just for an example of what small interest rate changes do to payments.

You might wonder what kind of savings you can get with a lower mortgage rate, or what a higher mortgage rate will do to your payments so let’s look at some examples.

So the variables in mortgages are amount, (amortization) term and rate. We will use 25 year amortization periods for all examples and the same mortgage amount for everything so we can compare ‘apples to apples’ – how about a \$300,000 mortgage amount.

If you have a rate of 4.0%, with all else being equal, your payments will be: \$1578/month

But if you had a rate of 3.5%, your payments would be: \$1498/month

And if your mortgage rate was 4.1%, your payments would be \$1594/month

So getting a rate of 3.5% instead of 4.0% would save you about \$80/month

And having to pay 4.1% instead of 4.0% would cost you an extra \$16/month

So you can see that a tenth of a percentage point doesn’t really make a huge difference on your monthly payment. But what does that add up to over the life of the mortgage. If you could get a 25 year term (which you can’t) and could pay the same payment for that long without re-negotiating, how much would you pay for your property?

At 4.0%, your total cost of borrowing after 25 years would be: \$173,418

At 3.5%, your total cost of borrowing after 25 years would be: \$149,343

At 4.1%, your total cost of borrowing after 25 years would be: \$178,310

So an increase from 4.0% to 4.1% would cost an extra \$4892 over 25 years – about \$196 more per year.

And a decrease from 4.0% to 3.5% would cost \$24,075 less over 25 years – about \$963 less per year.

I hope this helps illustrate how much interest rates affect your mortgage payments and total mortgage costs. The effect is not really as much as you might think. Of course all of this is augmented by higher mortgage prices, so do the math for each instance. However, the bottom line is if you can get a good rate and you feel they won’t go down anytime soon, it might be best to lock in that rate. However, it’s probably not best to hang back and not buy a place if the rates are reasonable. Saving even \$1000 per year is not worth renting as far as I can see. And that \$1000 is hard to come by. It would be rare to see mortgage rates offered that much lower in one place from another. But if you do see a great deal like that, now you know what it’s actually worth.

If rates are different by many percentage points, then of course the differences would be greatly magnified, but when you’re shopping around for rates or are looking to wait for a few months, it’s not likely to make a huge difference – rates just don’t change that fast these days. Of course every dollar counts, but time is important, too. If it really is just a small percentage, it will still be a small difference.