Author Topic: Mortgage interest rate WAY higher than nominal rate  (Read 745 times)

tony.james

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Mortgage interest rate WAY higher than nominal rate
« on: April 03, 2019, 04:08:02 AM »
Hi there

I was going through my mortgage documentation today. While the nominal rate is quite low at 1.3% (keep in mind this is in Singapore), I saw something on the paperwork that shocked me...

They gave a comparison of the original loan amount and the projected amount that would be paid back over the life of the loan, then stated: "This means you will pay back $1.19 for every $1 borrowed."

Oh. My. God. Does that mean the effective interest rate is 19%? Surely it can't be and my lack of knowledge around mortgage payments and interest rates is embarrassing me here, but goodness!

So with that said, I want to pose the following question. Since it appears to be a much higher interest rate than the 1.3% stated, and assuming index funds will get me 7-8% (give or take), should I be piling all my cash into paying off that mortgage first since the interest rate appears to be much higher than the investment returns I could otherwise generate?

I'm really hoping I've tripped up somewhere over the basics, but please do set me straight.

red_pill

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Re: Mortgage interest rate WAY higher than nominal rate
« Reply #1 on: April 03, 2019, 04:59:29 AM »
I suspect you are reading it wrong, or at least thinking of it wrong.  I think you are comparing your expected annual rate of return on an investment against the total cost of borrowing of your mortgage. So comparing one year of results to thirty years of results.  Of course they arenít going to be the same.

Look at it this way - if you had $5,000 in your pocket right now, would you be better off paying down your mortgage and avoiding that 1.3% interest, or investing it and potentially earning X%.   

You could use an amortization calculator and an investment calculator to get an apples to apples comparison if you like, but really you donít need anything beyond comparing your mortgage interest rate to your anticipated rate of return.  Mathematically the answer is clear.  Itís when you add in risk adversion, debt adversion, psychology factors,, etc that you might tip the balance depending on your personal preferences.

Maybe someone else can lay it out a bit clearer. 

SKL-HOU

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Re: Mortgage interest rate WAY higher than nominal rate
« Reply #2 on: April 03, 2019, 05:05:17 AM »
Every year that you donít pay off that $1, you pay the interest so if your mortgage is 20-30 years, it is possible that in the end that is what you end up paying.
But that doesnít mean you should throw all your money at it. Because with the same token, if you invest that money, you would be getting a much higher rate of return every year making the ďeffectiveĒ earnings a lot more.
« Last Edit: April 03, 2019, 05:07:19 AM by SKL-HOU »

Dicey

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Re: Mortgage interest rate WAY higher than nominal rate
« Reply #3 on: April 03, 2019, 05:14:51 AM »
I think you're asking the wrong people the wrong question. Talk to your mortgage holder first. Get the facts, then we'll help you make the best decision.

Steeze

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Re: Mortgage interest rate WAY higher than nominal rate
« Reply #4 on: April 03, 2019, 05:36:20 AM »
I recently got a mortgage in the states, they gave the annual interest rate of 4%, but also gave the total interest paid as a percent of the original loan amount if I were to pay it off over the full (10yr) term. This gave a value in the double digit %, but keep in mind that is the compounded number. In my case it would be something like I pay 1.48$ for every dollar borrowed over 10 years. Likely the 1.19$ is the compounded interest over the full term.

ender

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Re: Mortgage interest rate WAY higher than nominal rate
« Reply #5 on: April 03, 2019, 05:42:39 AM »
I recently got a mortgage in the states, they gave the annual interest rate of 4%, but also gave the total interest paid as a percent of the original loan amount if I were to pay it off over the full (10yr) term. This gave a value in the double digit %, but keep in mind that is the compounded number. In my case it would be something like I pay 1.48$ for every dollar borrowed over 10 years. Likely the 1.19$ is the compounded interest over the full term.

This is my assumption too.

nereo

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Re: Mortgage interest rate WAY higher than nominal rate
« Reply #6 on: April 03, 2019, 06:11:07 AM »
I recently got a mortgage in the states, they gave the annual interest rate of 4%, but also gave the total interest paid as a percent of the original loan amount if I were to pay it off over the full (10yr) term. This gave a value in the double digit %, but keep in mind that is the compounded number. In my case it would be something like I pay 1.48$ for every dollar borrowed over 10 years. Likely the 1.19$ is the compounded interest over the full term.

This is my assumption too.

To illustrate the point:  If one were offered a 3.5% interest rate on a $200,000 loan paid off over 30 years in monthly installments, the total interest paid would be $123,312.  Total payments would be $323,312. 

For every dollar borrowed you would pay back $1.616 on that 3.5% loan over a 30 year term.


This is not unusual, and in fact how loans are supposed to work.  Each year you will make ~$10.8k in payments. In year one you will pay down about $3.8k in principle and $6.9k towards interest (remember that the $200k will accrue interest of almost $7k in year one -- $200k * 3.5% = $7k).  As the principle goes down the annual interest which accrues also goes down, and your fixed monthly payments make a bigger and bigger dent in the principle.