What would you do if you knew the future? Would that change your decisions today?
Paying off your loans early, especially on big ticket items, can save you tens of thousands in your lifetime. All it takes is a small, extra contribution each time you pay.
When we looked at the savings from paying just an extra 10% each month on your mortgage, you owned your million dollar house almost 3 years earlier, and saved almost $50,000.
But there was one major element that we overlooked for simplicity. We didn’t consider the future.
What does Tomorrow look like?
In our preliminary analysis, we assumed that the future would be exactly like today. In that I mean, we didn’t account for an increase in interest rates above the historic lows that we’re experiencing today.
But interest rates will increase.
And that increase might come sooner than you think.
How to Predict the Future
Anticipating changes in the economy is an exceptionally complex task, one that nobody can get perfectly correct all the time. While the specifics might be hard to get accurate, the general trends are easier to spot.
To start with, you need to look at the macroeconomic factors, or what is happening in the broader world. How much are consumers spending? Is inflation on the rise? What about government fiscal policy?
Ultimately, interest rates are determined by supply and demand. The more demand, the higher the interest rates can be asked.
In recent history, as a byproduct of COVID-19, governments have been printing money, effectively increasing the supply of capital. This drove interest rates down. But, as government stimulus is slowly retracted, that extra capital in the economy will dry up, tightening the supply, and thus increasing interest rates.
Using a Crystal Ball
If all that analyzing macroeconomic trends seems complicated (it is), it might be a better idea to leave that to the experts. Assuming, of course, that most of you are not economists working on government fiscal policy.
If you, like most people, are not shaping fiscal policy, you can take a much easier approach to determining the future interest rates.
You could Google what the projected interest rates will be. From a reputable source, that will give you a good indicator. But there’s an easier way.
Instead, just pull out your crystal ball.
Undoubtedly you see commercials flickering across the TV during your favorite programs, or popping up on your Instagram feeds, or even YouTube’s advertisements. You’ll be able to see the changes in the economy through their promotions, deals, and advertising. The best example is from automotive manufacturers.
Three years ago, it was common to see “0% APR for 72 months”. Everyone was offering financing that was effectively free. Fast forward to today - what are those same advertised rates? A Toyota Rav-4 would see you holding over 3% interest for 36 months, or north of 4% for the equivalent 72-month term.
Those increasing rates, and higher rates for a longer term, indicate that the financial guru’s at fortune 500 companies are expecting rates to rise in the near future. Can you really afford to bet against them?
How Does This Impact You?
Maybe you aren’t in the market for a new car. But looking back at our mortgage example from earlier, the numbers can change significantly.
Remember our $800,000 mortgage on a million dollar home? With a 2.5% interest rate, our monthly payments were $3,161. On that first payment, almost $1,500 went to pay down principal.
If the rates were 5% instead, our monthly payment would be $4,295. An increase of $1,134 (35%) each month. And the amount of principal we pay down in that first month? Only $961.
An increase in interest rates can radically alter the cost of anything that you have financed, nothing more so than your home. While 5% might sound steep right now, remember that the economy has seen mortgage interest rates well over 10%.
Which brings us back to pre-paying your loans. The savings of 2.5% in interest, while nice, might only save you $50,000 over 30 years. But when (not if) interest rates do rise, and your fixed interest term is up, the new rates you’ll be offered might not be quite so rosy. Your monthly payments will increase, and the total cost of your home skyrockets.
Paying more down now will mean you have to refinance less in the future at potentially higher interest rates. This single act makes your savings on interest jump from $50,000 to a much higher number. Not only that, you won’t suffer as much a change in your monthly payments.
We are experiencing a golden opportunity for anyone looking to make a big ticket purchase. The cost of borrowing is dirt cheap, and those goods will never be this cheap ever again. If you do take the plunge, financing that new; car, boat, house, whatever. Make sure you are taking full advantage of the cheap rates, and paying down as much as you possibly can now.
This single act will make future you a whole lot happier, and a fair bit wealthier too!