interest rate and mortgage

chunfaat

2011-09-01 6:27 pm

I don't quite understand the relation between interest rate and mortgage. Can someone answer the following example?

"When interest rates fell, the homeowner tends to repay at lower rates. This left the mortgage bondholder holding cash."

The book said this was no problem if the investor could reinvest in at the same rate interest as the original loan, or at higher rate. But if interest rates had fallen the investor lost out. Why is this???

*I thought interest rate just affect the amount of interest that return to the borrower, so at worst will be 0% that is no interest but still can get back the capital, how will he lost out?

Thanks.

更新1:

I see, your example is much better. But I'm still unsure at one point, when you say "If you have certain amount of cash to put in saving, then the net mortgage rate is 2-0.5 % = 1.5 %" Why are you linking the saving with the mortgage? Sry, I know very little on the banking system...

更新2:

Similarly, in the 4% interest of buying shares, why again you have to minus 2%?

回答 (1)

Veronica

2011-09-01 7:03 pm

✔ 最佳答案

Well, although cannot fully understand all your words. Let’s put it in simple ways. The main concern of your question is the “ rate difference” Note: mortgage rate is related to interest rate, a prime rate , P Let ( number is not realistic , just an example) 1. interest rate of saving= 0.5 % 2. mortgage rate = P-3.25 %, while P=5.25, so, the final rate is 2 % If you have certain amount of cash to put in saving, then the net mortgage rate is 2-0.5 % = 1.5 % If there is some ways for one to gain higher return ( interest rate or, exactly, investment return), for example, buy shares that offer high interest (e.g. 4 %) like CLP or BOC, then the net interest is 4 % - 2 % = 2 % (gain) This explain why many people tend to buy property to rent out now. If they have money, instead of saving in hank They buy a house, get mortgage at rate P-3 = 2.25 % The rent out at 4 % return, then for them, they have net gain of interest ( return) of 4-2.25 %= 1.75 % The 1.75 % net return is much better than in saving a/c ! (i.e. 0.01 %) So, in a low interest rate time (P is low), people tend to invest rather than paying mortgage !

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