In 2020, we decided to take the plunge and buy a house. We started looking at the end of January and we settled at the end of February, moving before Easter. It all happened very, very fast.
This was before Covid was "a thing".
We had the option for a loan collar up to 10 years. The loans manager said it wasn't common, but I was adamant. When we talked to the neighbors about it, they said it was a waste of money. When I told my colleague, he said it was a waste too. Why pay that bit extra when it could go to other things? They didn't understand my argument that interest rates are the lowest they have ever been and they only have one way to go.
This morning, I was reminded of this, as my colleagues were talking about their loans changing, where their reference rates have shifted significantly. The reference rate is the benchmark interest rate and then on top of that, the bank will add its margin.
For example in the EU, the Euribor is the blocs reference rate, and with the collar we have on the loan, it references the 6-month Euribor. This is also affected by the loan, but it means that every six months, the loan interest rate will update.
As you can see from the year column, the last seven years, the interest rate has been negative. That didn't cause any problems at all... But, this "negative" is why my friends thought me crazy to be paying a bit extra for the collar, because interest rates were crazy low already, even after the margin.
The Loan collar has an upper limit, but it also has a lower limit, which means that if reference interest rates are even lower than that, we would be paying more for the loan. Which we were.
But, we had a good deal.
Or so we thought.
In mid-2021, we found out that the collar hadn't actually been applied to our loan at all, but we hadn't noticed this in the contract. This was a pretty rough time, because the bank no longer had the collar option at all, because they could see where interest rates were going, as could I -
And I had just suffered a stroke.
But after much fighting, we were able to get the collar put on for ten years starting from the new date, albeit at a higher maximum reference, but they waved the setup fee. And while it was difficult and at times my wife was ready to give up (as she was handling this as I couldn't at all), the stress was worth it and now, she is very happy I was still adamant.
Because, this is our loan:
We are paying 1.65% including margin, which is the highest it can go for the next 8 years! You can see that the maximum reference is 1.20 (originally it was 0.98, but they screwed up and screwed us), but the current reference is 3.14, which would have been the Euribor around mid-January.
What difference does it make?
Using ~200,000€ as the base of a 35 year loan, with current margin of 0.8 and full reference rate:
Using ~200,000€ as the base of a 35 year loan, with interest at 1.7%
Now, while not exactly the loan deal we have, there are a couple of interesting things to note here. Firstly of course, is the monthly repayment difference of 327€ a month. That is enormous for most people and is about 10% of an average salary, before tax. The next thing to note is interest cost difference over the life of the loans, which has the top one costing 132,000€ more over the lifetime.
And this hints at a very important factor.
Loan 1 at 4.45%, paying 950€ a month
Loan 2 at 1.7% paying 637€ a month
In the first loan, paying 950€ only reduces the principle 199€. In the second though, the reduction is 350€, 75% more. Paying less, paying off faster. And it is this that my wife and I have to start taking more advantage of, by paying it off faster while we have the collar in place.
The reason is that with the higher inflation, money is losing value, but we are effectively getting a discount on our loan in comparison to the value. This means that when we put an extra 100€ in a month, it is actually going to have a greater value when spent on our loan, than if we were to use it to buy something, because in our loan, we are locked into "old value" of money.
For instance, Buying something for 100€ two years ago, would cost around 120€ today, at the average inflation rate. But, putting that 100€ into the loan, is getting the 100€ value, that can only buy about 80€ of something in the shops now. It means that we could significantly shorten our loan, by using todays money, in the past - if that makes sense. Because our loan isn't subject to inflation from here for the next eight years, everything we put into it while the rates are up, has a supercharged effect on the loan.
My friend was saying today that his loan has changed significantly in length, because when he bought the house about five years ago, he would pay 1000€ a month and 900 would reduce the principle, now it has almost reversed, where he is paying the same monthly, but now only 200 goes to reducing the principle.
And, a lot of people are choosing to pay "interest only" on their loans at the moment to make ends meet, which means that the interest isn't reducing at all and the loan is getting longer, and longer.
I know what you are saying...
Taraz, that was a boring-ass post!
Yes. Maybe.
Or is it?
Probably.
But, what is interesting about it is what I was discussing with my colleagues this morning. Both of them are smart people who have good jobs and are generally financially savvy, yet - neither of them took a collar because of the tiny price it cost above what they could pay in the moment. And when I said that I don't get how people can't predict this kind of future with rising interest rates, they both said,
"but I didn't expect it to go up so fast."
But again, the lowest interest rates have ever been and, they have a loan that spans half a lifetime. The chances of it going up in that time are good, especially since they had been declining for so long. The cost of a ten year collar is a fraction of the cost of interest rates moving up even by 1% - but it was still too high of a price.
Loans suck.
So the plan should be to reduce them as fast as possible with disposable income, if there isn't a better investment to spend on. At the moment for my wife and I with the collar, it is again an investment to pay it off faster, because we are getting our loan at that discount. It is like getting a 20% bonus on everything extra we put into the loan, which can make a big difference when that collar comes off.
As part of the common workplace agreements, both my wife and I will get the base 3% salary increase and I was saying tonight, I know where it is going to go. It isn't worth much in the real world, but putting it in the loan today, means it is actually a 3.6% increase and, it also reduces the loan at a faster rate, so it has even a little more value than that.
May as well put it to work.
One of those small steps that compounds, in action.
Taraz
[ Gen1: Hive ]
Posted Using LeoFinance Beta
I didn't think that things could be more complicated in the world of finance with a dearth of products and services designed to try and extract as much money from people as possible. Today I learned about this "collared" loan product.
Things seem to be simpler here. It is much more obvious that you are getting reamed by financial institutions, and it is plain in view on their balance sheets. The "nice" things they did during COVID lockdowns to try and seem charitable to most people actually will, in the long run, extract more profit from those people.
And now with interest rates skyrocketing, it is a double pay day for those banks. It is really misleading conduct that regulators don't seem to care about. That is depressing, because here, financial literacy is very low indeed.
I'm really glad that you were adamant to take advantage of the stay on interest rates, and I'm also really glad that your stroke wasn't more serious. I don't think I ever formally said that; but it was always thought.
They have collared loans there too, but I think the max is three years. I also think that most of them are going to be expiring in the next six months, so all those FOMO Covid homes bought are going to have some unhappy mortgage payers.
I don't know if it is easier, but you are definitely getting reamed. In Sweden, they have "100 year loans" that you can pass to your kids - and grandkids. Then you have more disposable income to spend on crap. Housing is very expensive there.
As if the banks didn't know what was coming. Pump money into the economy at unprecedented amounts, it causes inflation. The response to inflation is increasing interest rates.
It was higher here, but it is falling fast in the younger generations.
Cheers mate :)
This is what "I just woke up brain looks like" = collared = fixed. We just use different terminology.
The way I interpreted it made it sound like it was a mechanism to prevent the rate of the loan exceeding a certain value, but not staying at a constant value throughout the period. My misunderstanding is corrected.
Our loan was fixed for the first 3 years, while we built a pool of savings. After that three years, we got an "offset" which basically ... uh, "offsets" you remaining balance against your savings.
So, owe 100k, have 30k in savings, pay interest on the 70k difference only. This is often "offset" by a higher interest rate, and additional fees, so you never win, unless you have a substantial offset balance. You can further use the bank's own products against them, by employing credit cards. Put all your expenses on credit cards, keep your savings in the "offset", then pay the credit card off a day before any charges start gaining interest there.
Labour intensive, but a small victory.
I envy people who had the foresight to lock in their rates as I had a colleague who fixed in a 1.7% fix rate for 10 years on his home. He did have to hunt around and pay a decent amount for it.
I too bought my place during COVID and am one of those thousands of people who have come off a fixed rate to a variable rate, so the pain is definitely felt here too.
I believe fixed is slightly different from collared as the fixed rate doesn't change for the duration of it. But collared seems to be a fixed range that the rate can move in. So in Taraz's case, his rate could go below the 1.65% he has been paying......that's mind boggling when I think of my variable rate.....which is 5%+
I am doing what you are doing, all expenses on the credit card (sans the stupid places that charge you 2% to use a credit card) all savings in the offset accounts (yes, you can have multiple offset accounts set up) then pay my credit card bills a few days before they are due. A bit of work for sure, but the perception of beating the bank is worth it!
About 60% of my mortgage is offset (and I've had 6 years to chip away at it)
I got a really modest place, well below my means, but its cosy, warm, and now has solar! :D
I could go back to fixed, or split the loan to get that perception of "beating the bank" even more, but the administrative effort involved in this case doesn't feel worth while.
I think my variable rate is about 5.4% at the moment.
You have already offset 60% of your mortgage! That's amazing. I still need to work really hard on mine:(
I think this is the reason why so many Aussies are struggling right now. You need to get a place that is below your means, and not max out your lending capacity. Neighbour envy is so strong here and people get sucked into it and now that there isn't anymore cheap interest rates......
I've got the best neighbours. One is an old bloke in his 70s who has a dark sense of humour, loves pizza and science fiction, the other is a lady in her 90s who will give you a hug and biscuits for helping her unjam her gate when it gets stuck.
I'll be sad when they move on. Very sad. (Here's hoping I outlive them both)
As long as you pay it all off each month, it can be great. they don't do it here as far as I know.
Yep - I have just got used to it here. The straight translation here is "interest roof"
Yep. If good with money management, this works wonders. Unfortunately, most aren't and get trapped paying higher interest anyway.
That's how the banks make money, all they rely on is the 10-20% who get it wrong and they are gold. And it's not just money management, it's financial knowledge as well which is severely lacking in Australia.
Let me tell you a story I heard on a tram quite a while ago and I have told to so many other people.
Two young males (18~20) were chatting on the tram and one of them mentioned he was going to take a loan to buy a $10k motorbike. Then his friend mentioned that he should take a $15k loan instead and put the $5k in a savings account and get interest. Whoops and high fives and they went on their merry way.
Spot the mistake in the paragraph above :D
Wow those interest rates are fantastic to the ones we are seeing over here. Hopefully the housing market is not as nuts there too. 2020 would have been a great time to get into the market here as prices managed to blow up over Covid due to lack of demand and the rich snapping up bargains at the hands of those in financial peril due to lockdowns and such.
I was lucky enough to get into the housing market 20 years ago. Back then it seemed I was probably paying too much but the prices are 4x what they were then so it was a good investment. Even carpetbagging my initial investment to move to a small town and get twice the house at half the price has worked out well. Even in this house, the value is 3x what we spent on it at least and that is in a slightly cooling market.
As supply has been screwed with by investors buying extra properties, they have compounded the problem by converting them into air BnBs, effectively taking them off the market for renters. So, prices are way up to buy, and so is rent as so many of them sit empty 80% of the time so that they can become hotel rooms.
I feel sorry for those starting their lives and families out of school. Entry level salaries are probably close to what they were 20 years ago and prices on homes and rentals are at least 4x. That math does not work. I believe I may have kids living at home after college! AGH!
While having a big capital asset with not that much mortgage remaining is a good thing, it certainly doesn't help with disposable income or lifestyle! I will sit on (in?) that investment like I do on my Hive capital!
As was I! - 25 actually - but it got sold after I came to Finland to help cover my mum's expenses due to cancer. That same house now is about 3x as well... crazy.
This has been a massive issue in Australia from what I hear. Renters can't afford to rent or buy, and there are heaps of empty apartments, making their money being rented out a couple days a week.
This was an interesting article from a few months back:
"Slab of VB" = 24 pack of Victoria Bitter beer.
https://www.news.com.au/finance/economy/australian-economy/how-many-slabs-of-vb-it-takes-to-buy-a-house/news-story/89b555ef2685ba51ed6e20616aeef8c6
Great move. I did something similar too a few years back, whereby I took on a "higher" rate using the government offered interest rates on our retirement accounts. This was during a time where bank interests were at an all time low and everyone was saying it'd be silly to pay that slightly higher rate.
I liked the stability and guarantee offered though, and didn't think it was possible for the bank rates to stay that low forever. Take note that in my country, once you reject that "government" loan option, you can never ever go back to it.
I see lots of worried neighbours around me now fretting about when their loan is due to be refinanced and the significantly higher rates kick in. Bullet dodged I guess.
Sometimes it comes down to luck of the draw and timing. We were lucky with the timing, but smart with taking the option. A lot of people who should have known better, didn't take the option, though their timing was okay. It is "sliding doors" in some cases though.
I have a lot of bullet wounds in my life, but will take this as a win :)
The value of the houses of those who took mortgage in 2020 during the pandemic in my country, has risen more than ten times in three years. This is an insane investment which is done unwittingly.
That's crazy!!!
Do you think EU will have Crypto collateral loan system in near future? I was thinking about it. I feel bitcoin based loans can be a thing. And there would be chances of paying it back through crypto itself or even through FIAT. I feel a lot of people who can't have big salary jobs but they have earned crypto with HIVE can get an edge in life if they approach the loan like this. What do you feel?
I feel it will be a while before they have it here. There seems more pressure to crackdown on everything that threatens the system at the moment. Controllers are going to control.
We can get 10 years but went for another 4 years fixed after our original 2 years fixed. Even in that space the prices have jumped so high but we are still below market rates. Luckily it's a reasonably priced house but we have outgrown it with two kids and the need for a home office now.
You got a great deal overall even if they fucked you a little bit. Paying off early is key to a mortgage and one good bull run could make a serious dent in that.
We're going viewing house this week looking to go bigger so it will be interesting to see how we get on with the banks when we try to go from a 250k home to a 450k home.
Anything below is worth it. Paying off a little more for the bonus is too. which is why I am hoping for...
Good luck on the hunt!
Ah, so like ten years fixed and then it is a variable rate past that? How does that feel? We bought our house about six years ago on a thirty year fixed. The idea of paying on a house until I am seventy wasn't very appealing to me, but we had little choice. Now we are starting to look for a different house! Oye! The good news is, with our low rate (3.75), I have been paying extra each month.
It feels good at the moment! Which is why I am hoping to knock most of it out in the next 8 years so as not to worry too much about the variable change.
It is definitely all relative. US earn relatively more than us in Finland too :)
I don't know about that last part. I'm in the public sector. I don't make squat! When we find a house to buy again I would love to get a 15 or 20 year mortgage versus a 30 year one.
Loans suck but good job getting back that fixed rate. I always think that having a fixed rate is better because it removes variables and nobody would know how long it takes to pay everything off. It's kind of crazy how things have changed in a few years since the lockdowns.
Posted Using LeoFinance Beta
Most people buying in the last decade haven't really experienced high interest rates before (many countries), so they don't necessarily know what kind of affect it will have. We aren't good with compound interest, or visualizing the impact of percentage changes.
Many of my friends who subscribed a loan a few years ago are moving from "variable" interest rates to "fixed" interest rates, where you pay the same interest throughout the whole period, as the increase they have experienced is insane. They are paying extra for the process and those with many-year loans will probably experience the opposite direction after a few years, but then their principal will be much lower and the effect in the cost will be lower.
It is amazing how many people do not make the exercise of analyzing a financial product over the period of time it will last. We are used to "recent time" purchases but a loan is something you will carry for many years and you should do some analysis before closing final conditions as experiencing one or two different financial cycles is the minimum it will happen during the live span.
In some cases, having the fixed repayment rate but varying loan length can be good for people, because it gives them some stability in terms of knowing costs. But, it can also get out of hand, continually kicking the can down the road.
We have talked about it before, but I think it is just that we are becoming increasingly shortsighted in every area. We want it now, so put it on credit, and the size of loan we are willing to take is getting larger. Prices go up - more credit. It was unheard of a few years ago here, that people would use a credit card for a meal - but getting more normal now.
I think this is one of the advantages that people from other country have over we Nigerians. We do not have anything like this loan in my country.
If we have it, a lot of people will not be suffering or be left jobless. Also, the interest rate seem not to be much unlike the one that microfinance banks charge here. They may charge you thirty percent on your loan for just one month. That can be very crazy.
This is why you see a lot of Nigerians travel to other countries because they believe that they can live a fulfilled life there.
When people are in need, they will pay anything and worry about the cost later. This is why loan sharks make money.
You are very savvy financially! @tarazkp
Not a boring-ass post whatsoever; quite the opposite. I was today-years-old when I first heard of and learned about the term "loan collar." My spouse and I are exploring buying our "forever house" in the next couple of years and will definitely look into a loan collar. Sadly we will miss getting a low interest rate.
I am not sure what they are called in different countries, but most banks have some form of them. We were lucky with our timing for sure.
Good luck on the forever home plans! =)
Definitely a genius move. I got a friend who paid extra for a fixed term mortgage and he must be laughing all the way to the bank these days. Maybe it is time I just start buying rentals so I have some way to build real estate equity because I just don't have it in me to settle down in a home for more than 3-5 years.
Here you can get a quick loan on the vamo.vn/vi/vay-tien-online-nhanh/ card at a low interest rate. Their requirements are minimal. Find more information on the website.