Calculate your own variable interest mortgage

CALCULATE YOUR OWN VARIABLE INTEREST MORTGAGE. Calculating your own mortgage might seem complicated, best left to professionals who know better, you might say. And although it is very wise to look for and follow reliable advice every step of the way when purchasing a home and signing a mortgage or home loan. Having said this it is invaluable when going into a serious investment like purchasing a home to understand the underlying factors that determine the cost of your home.

In this article and it’s sister, CALCULATE YOUR OWN FIXED INTEREST MORTGAGE, we try to demystify the world of mortgages and how to calculate them. As we explained in the above mentioned article calculating your own mortgage is much easier when your interest is fixed, or in other words is set for the whole tenure of the loan. Fixed mortgages are convenient for people with fixed income that like to budget their monthly payments for the long term. However the downside on these mortgages is that they are always of a higher interest than the variable interest mortgages. The reason for this is that banks, financial institutions and lending companies need to allow for a larger profit margin to cover the risk of the interest rate increasing significantly and destroying their profit.

That is why most of us have variable interest or A.R.M (Adjusted Rate Mortgages) mortgages. You can check our past articles for a more detailed analysis of these mortgages. Enough to say that variable interest mortgages change with time determined by the interest rate set by the financial institution, generally a state run organization, responsible of setting your national interest rate. In the United States this is set by the United States treasury, in Spain by “El Banco de España¨.

A.R.M are a different beast, they combine fixed rate interest for a set amount of time, and then are adjusted to a variable rate.

Calculating your own variable interest mortgage is rather similar to calculating your own fixed interest mortgage with the difference that you can´t be sure what the interest will be in the mid or long term. This guideline will help you in your calculation, a variation of a maximum of 2 percent and 6 throughout the whole term is a conservative estimate of what´s the worst the market can do. Although as we have seen in recent months with the current market, conservative estimates can be awfully wrong.

With this guideline, calculating our variable interest mortgage is easy. We get the same formula we used for fixed rate mortgages

A=P(1+i)^n

For more information on what the symbols mean please check the article CALCULATE YOUR OWN FIXED INTEREST MORTGAGE.

We now plug in our real data into the equation, the initial cost of the house, the tenure, and the current interest. This will give us the cost of the variable interest if it doesn´t change throughout the life of the loan. Not very likely but there you have it. Now increase the interest rate by six percent and recalculate. This will give you a worst case scenario.

Increase the interest by two per cent and you will get a conservative estimate. Now just for kicks drop the current interest rate by two per cent and look at your best case scenario, probably wont happen but wouldn´t it be nice. Please remember these totals will probably wont be the real cost of the home loan as variable interest loans are in constant flux, but it will give you a good idea of what you are getting yourself in.