The person who wants to take out a loan usually can choose what kind of interest fixed or floating he wants to pay to the bank. If the person has chosen fixed interest rate then he will have nothing to worry about. However, bank when issuing a loan offers higher fixed rates for the loan than for the loan with floating ones. Because of that people consider that it is better for them to take out a loan with floating interest rates as they hope to pay less interest. Thus, calculator which evaluates how much monthly repayment can change for the person who has taken out a loan can be a very useful tool not only for such person but also for those who consider taking out a loan and do not know which kind of interest rates to choose.
For explaining how this calculator works the standard example for comparing is where the person wants to take out a loan of £100,000 on repayment basis for 15 years and is offered by the bank an interest rate of 4.5% and a) +0.5 %, b) -0.5%, c) +1% change is anticipated.
It is obvious that the bigger the loan the higher additional amount of money the person is going to pay if interest rates change unfavorably. Of course, if the interest rates decrease an individual will win more if he has taken out a bigger loan. However, the question is what will be the impact of a change in interest rates.
Thus, if he takes out a loan of £100,000 for 15 years with an interest rate of 4.5%, he will have to pay £776 each month. For such loan interest increase of 0.5% would result in necessity to pay additional £28 each month (£336 a year), an interest while an interest decrease of 0.5% would result in monthly payment being lower by £26 a month (£312 a year). Interest increase of 1% would increase monthly payments by £55 each month (£660 a year).
However, if the loan amount would be a) £80,000 and b) £120,000 then increase of interest rate +0.5% would increase a monthly payment by a) £21 and b) £31. If interest rate decreases by 0.5% monthly payments would decrease by a) £20 and b) £30. An increase of 1% would result in monthly payments being higher by a) £42 a month and b) £63 a month. Thus in the last case for £120,000 an increase in interest rate by 1% can result in monthly payments being higher by 6,86% while for a loan of £80,000 the impact of such increase results in monthly payments being also higher by 6,86%. It means that an impact despite the loan size is the same; however these examples prove that the change of interest rates can be very costly for the person.
If the person takes out a loan on an interest only basis, he should expect that changes in interest rates are very dangerous for him financially. For the example, if the individual wants to take a loan of £100,000 with an interest rate of 4.5% for 15 years then the increase of an interest rate by 1% would result in monthly payments being higher by £83 each month (£996 a year) or by outrageous 22,13%. So if something serious happens in macroeconomic environment and the interest rates rises by for example 5%, then the person would have to pay £417 more each month (£5004 a year) and this would result in monthly payments being higher by 111,2%. Thus, for the person to take out an interest only based loan with floating rates can be very dangerous financial burden.
Current interest rate is not a very important factor when calculating about an impact of interest rate change. It is this way because the additional amount of money that is needed to pay is linked mainly to the loan amount and for how long this debt is being taken. Thus, if the person will take £100,000 of loan then the increase of interest rate by 0,5% would result in increased payments by £21 a month if the current interest rate is 0,15% and by £24 if the current interest rate is 8%.
Term of loan is more important factor than the current interest rate in these calculations. First of all, the longer the term of the loan, the more interest will be paid to financial institution. This leads to that the more interest is paid the bigger the sum that person pays to credit provider. Because of that, the impact of the increase in interest rates follows almost the same pattern as it was discussed with loan amount. Thus, the longer the term, the bigger the impact of interest rate changes.
For example, if the person decides to take a loan of £100,000 for 5 years with current interest rate of 4,5%, then the increase of 0,5% in interest rates would result in increased monthly payments by £23. If the loan term is 15 years other conditions the same, then this impact would increase to £26 a month and if the loan term is 30 years this impact would increase further to £30 a month. Thus, though the impact of loan term when interest rates increase is higher than compared to a current interest rate, this impact is not very significant.