Adding Perspective to Interest Rates

With interest rates having been at historic lows for the past couple of years, it is inevitable that they will continue to increase. Whether you finance your properties with variable or fixed interest rates, at some point your rate will adjust, and this will have a real impact on your cash flow. To add some perspective, I’m going to provide a simple chart that will help you figure out how much your monthly cash flows will be impacted by various changes in interest rates.

Monthly Cash Flow Impact

The tables below demonstrate in simple terms the impact that interest rate changes have on monthly cash flow. These tables assume a mortgage with a starting balance of $100,000 which compounds semi-annually (Canadian style). The first table below outlines the monthly payments across a variety of interest rates and amortization periods. The second table shows the increase in monthly payment which occurs with a 1% increase in interest rate.

A Simple Example

To put the table above to use, lets work through a simple example. In this example we have a property that we’ve purchased for $250,000 where we put 20% down, so our mortgage balance would be $200,000 ($250,000 x 80%). Since our mortgage balance is double the $100,000 amount represented by the tables, we will simply double any of the figures we look up for our example. Continuing with our example, lets assume that to maximize monthly cash flow early on, we opted for a 35 year amortization period and took a variable mortgage at prime rate (currently 3%). This means we are now making payments of $767.62 ($383.81 x 2) on our property. If interest rates increase by 1%, our monthly payment would increase by $113.98 ($56.99 x 2) per month. This in-turn reduces our cash flow by the same amount.

Reality Check

Boiling these tables and our example down to add perspective to interest rates, here is what you need to remember:

A 1% increase in interest rates will cost you about $50-60 per month for every $100,000 worth of mortgage on your property.

If you’re worried about increasing rates, consider that your reality check. You can now put things in perspective and see what the impact would be on your portfolio.

What You Can Do Today

While there is not much you can do to keep interest rates low, here are a couple of ideas to help you survive a rising rate environment:

• Buy strong cash flow – Don’t buy properties that will only provide positive cash flow while money is cheap. Stress test your properties to ensure they will still put money in your pocket every month when rates go up.
• Use excess cash flow wisely – Instead of spending the extra cash flow most of us are enjoying right now while rates are low, use it to build a reserve that can cover any negative cash flow resulting from higher rates in the future or pay down additional principal

Enjoy the low rates while they last, because soon enough the pendulum will swing and we’ll be left to reminisce about “the good ‘ol days” of historically low interest rates.