When a homebuyer applies for a mortgage, they will most likely be presented with one of two interest accrual options, those being a fixed-rated or variable-rate mortgage. As can be anticipated from the name, the primary difference between these two borrowing types is the way in which interest rates can modify over the course of the loan. Unlike a fixed-rate loan, a variable-rate loan has the potential to modify interest rates at multiple points throughout the lifespan of the loan. You can use a simple mathematical formula to better understand how these repricing periods will affect your bottom line.
TL;DR (Too Long; Didn't Read)
A variable-rate interest loan calculates interest payments in a fundamentally different way than a fixed-rate interest loan. You can use a relatively simple mathematical formula to determine how much interest you will accrue on a yearly basis following your interest rate repricing.
Basics of Variable-Rate Loans
A variable-rate loan allows lenders to create a fluctuating interest rate schedule throughout the lifespan of borrowing. For some borrowers, the appeal of a variable-rate loan lies in the fact that interest rates may be substantially lower than a fixed-rate loan for the first several months or years of borrowing. However, borrowers should pay careful attention to the interest rate repricing schedule in order to determine whether or not a variable-rate loan is cost effective to them over time.
As part of federal law governing mortgage information disclosure, lenders must provide the full interest rate schedule for variable-rate mortgages to the borrower before they enter into a contract. At this point, the borrower will have the information they need to make an informed decision based on their financial circumstances.
Calculating Loan Repricing
Although the idea of a variable-rate mortgage may initially seem somewhat complex, the process of calculating the impact of the loan repricing is actually relatively straightforward. In order to determine how much interest will be paid over a specific repricing period, your first step should be to determine your current principal balance and the new annual percentage rate. Convert the APR to decimal form by dividing the percentage figure by 100. So, a 4.5 percent APR is equivalent to .045 in decimal form. Then, multiply this amount by the current principal balance to determine how much interest you will pay for that year.
So, if your current principal balance is $123,300, the amount of interest paid that year with a 4.5 percent APR would be $5,548.50. To further explore the impact of the repricing, subtract the previous year's interest rate payments from your new repricing. For example, if you paid $4,420.00 last year in interest, you would be facing an increase of $1,128.50 in interest payments for the year following the repricing.
Repricing Over the Life of the Loan
Although the information included thus far will allow you to price your loan for a single year, knowing how to determine the impact of multiple variable rate repricing over the life of the loan is also critical. While it is possible to calculate this manually, a far more expedited approach is to take advantage of one of many online loan amortization calculators specializing in variable interest rates. For example, the online calculator provided by Bankrate allows users to fully customize all data parameters to find information relating directly to their loan. This is one of many online calculators providing these services today.
Preparing For Loan Repricing
While it may never be a great feeling to realize that you are about to pay a significantly larger sum of interest over the next year, calculating this data at an early stage will allow you to prepare financially for interest rate repricing however often they occur. Thanks to the schedule provided by the lender, borrowers should have ample time to assess the impact of their next repricing and ensure that they have access to the funds they need to successfully make these payments on time. For those who may need additional assistance, a mortgage lender or financial adviser can provide advice and consultation on these topics.
Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community.