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- Aug 26, 2008
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- 731
Pardon me while I be "that guy" who has to interject with a "well, actually", but this article that was posted recently has some unfortunate errors in the analysis.
http://myreinspace.com/announcements1/f/123/t/20851.aspx
The issue is that the payments presented in the variable rate scenario are not correct. Starting with month 36 in the five year cycle, the original payment of $1586.20 isn't high enough to cover the new payment at an interest rate of 4.15% or higher, without extending the amortization. So the payments will have to increase and the total cash outlay in each scheme is NOT equal.
By my calculations, the total cash expenditure in the variable scenario (keeping the payment at $1586.20 for 35 payments, then increasing as required) is $97,904. which is $2,396 GREATER than the fixed scenario.
The interest payment difference is approximately the $5,000 indicated, but the principal balances in the variable scenario after payment 35 are also incorrect. The ending principal balance in the variable scenario should be closer to $253,568, not $256,391.
So the higher-payment variable scheme does save interest over five years and does pay down the mortgage principal faster, but it does so at the expense of cash flow and of opportunity cost on the money used for the extra principal paid down. The overall corrected variable analysis looks like this:
Total payments: $97,904 ($2396 > fixed)
Interest paid: $51,473 ($5,580 < fixed)
Principal balance: $253,569 ($7975 < fixed)
Total savings vs fixed: $11,159
A more typical variable loan with payments adjusting with each rate change would have the following attributes:
Total payments: $93,044 ($2128 < than fixed)
Interest paid: $52,320 ($4,732 < than fixed)
Principal balance: $259,275 ($2113 < than fixed)
Total savings vs fixed: $8,973
So there appears to be a small $2000 benefit to using the higher payment amount for the variable loan, albeit at the cost of lower cash flow (particularly in the first 3 yrs of the loan) and a higher overall cash outlay. I would think that most investors would want to opt for the route that maximizes cash flow in the early years, where it is typically harder to achieve.
Here is the google spreadsheet I used for this analysis. I welcome your input on its accuracy.
Thoughts?
ps. It's not clear to me what compounding period was used in the initial analysis? Doesn't seem to jive with my calculations using either monthly or semi-annual compounding.
http://myreinspace.com/announcements1/f/123/t/20851.aspx
The issue is that the payments presented in the variable rate scenario are not correct. Starting with month 36 in the five year cycle, the original payment of $1586.20 isn't high enough to cover the new payment at an interest rate of 4.15% or higher, without extending the amortization. So the payments will have to increase and the total cash outlay in each scheme is NOT equal.
By my calculations, the total cash expenditure in the variable scenario (keeping the payment at $1586.20 for 35 payments, then increasing as required) is $97,904. which is $2,396 GREATER than the fixed scenario.
The interest payment difference is approximately the $5,000 indicated, but the principal balances in the variable scenario after payment 35 are also incorrect. The ending principal balance in the variable scenario should be closer to $253,568, not $256,391.
So the higher-payment variable scheme does save interest over five years and does pay down the mortgage principal faster, but it does so at the expense of cash flow and of opportunity cost on the money used for the extra principal paid down. The overall corrected variable analysis looks like this:
Total payments: $97,904 ($2396 > fixed)
Interest paid: $51,473 ($5,580 < fixed)
Principal balance: $253,569 ($7975 < fixed)
Total savings vs fixed: $11,159
A more typical variable loan with payments adjusting with each rate change would have the following attributes:
Total payments: $93,044 ($2128 < than fixed)
Interest paid: $52,320 ($4,732 < than fixed)
Principal balance: $259,275 ($2113 < than fixed)
Total savings vs fixed: $8,973
So there appears to be a small $2000 benefit to using the higher payment amount for the variable loan, albeit at the cost of lower cash flow (particularly in the first 3 yrs of the loan) and a higher overall cash outlay. I would think that most investors would want to opt for the route that maximizes cash flow in the early years, where it is typically harder to achieve.
Here is the google spreadsheet I used for this analysis. I welcome your input on its accuracy.
Thoughts?
ps. It's not clear to me what compounding period was used in the initial analysis? Doesn't seem to jive with my calculations using either monthly or semi-annual compounding.