mortgage repayment strategy - make use of inflation to erode debt?

bleaky

Hi,

This is my first post here. I have developed some ideas about repaying my mortgage (which I am about to transfer to a new lender), which while large, is still only 3.5 times my salary in size.

I have a choice between going for a capital repayment or interest only product, both of which allow overpayment. Everything I have seen and read to date about the current economic crisis is telling me I should get an IO product. I'll list my reasons here and see whether you seasoned savers here agree or not.

1) Since the UK will shortly be a nation in which a huge swathe of consumers are burdened with terrible debt and negative equity which may not work itself out of the system for decades, it seems to me that the government may well choose to simply inflate sterling until these debts are eroded to a level at which the average joe can pay it back, and start spending again, thus kickstartnig the economy again. If this is to happen, any money I put against that debt before this period of high (hyper) inflation is going to be wasted.

I also anticpate that over the next decade the £ will get seriously devalued, either as a steady erosion or as a sudden event like when we fell out of the ERM. Overall I think it wise to move wealth out of £ (and $) denominated assests.

2) In order to protect one's savings from inflation while allowing inflation to erode the debt the savings must be in a place where they will be less eroded than the debt. This requires an IO product to allow the flexibility to pay into such investments.

3) The other possibility that should be considered is deflation, where debt effectively increases since all other assets but cash (and maybe gold) go down, including salaries. In this event the best strategy is probably to pay the debt off directly. So as long as the IO mortgage allows flexible overpayment, this option remains open.

4) Given the extreme future uncertainty we now have, keeping debt repayments in liquid form may well be advisable. I'm not clear whether if I lost employment my house were repossed, whether my investment I have made instead of mortgage repayments can be taken by the bank. In any case having liquid funds could allow me the time to find new employment at the expense of regressing on paying off my mortgage.

Does this appear to be a sound, or dangerous strategy?

Floxxie

Welcome Bleaky,

I have had exactly the same thoughts. My reasons also include that I may wish to move in the future but my type of house is hard to sell in good times so I propose to rent this out and then use the saved money as a deposit for another purchase.

I'm only looking at putting the difference betwwen the repayment and IO in an offset pot. I just need to see the figures to understand if it is worth doing.

Floxxie

StuartGMC

bleaky wrote: »

I'm not clear whether if I lost employment my house were repossed, whether my investment I have made instead of mortgage repayments can be taken by the bank. In any case having liquid funds could allow me the time to find new employment at the expense of regressing on paying off my mortgage.

Bleaky
A good series of questions, which I will leave others to consider. I would comment on your final point above related to the repossession; you are responsible for the debt remaining, i.e. the difference in the outstanding capital and the value the lender can realise (via auction) for your property.

Back in the last recession some people thought all they had to do was hand the keys back and all was cleared, they then came in for a nasty shock once the property was auctioned (well below "market" value) and they still had to clear the difference. So, in your case, insurance to bridge the period if redundancy or company closure may be worth considering. In my case in 1992, company went into receivership and was closed down immediately; no redundancy pay (was due 3 months salary) other than a few £ from the Government.

Your decisions, but risk is the product of likelihood x consequence so you should be able to do some what-if scenarios.

Good luck

Jonbvn

The real problem is that instead of inflation, we could be looking at a Japan style period of deflation.
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3218075/Britain-faces-deflation-for-first-time-since-1960.html

If this happens (a lot of people think it likely) then an IO mtg would be a serious mistake.

bleaky

Jonbvn wrote: »

The real problem is that instead of inflation, we could be looking at a Japan style period of deflation.
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3218075/Britain-faces-deflation-for-first-time-since-1960.html

If this happens (a lot of people think it likely) then an IO mtg would be a serious mistake.

In which case presumably the best bet is to just pay the mortgage off directly during this period of deflation? From what I can see an IO mortgage allowing flexible overpayment is in effect the best hedge against an uncertain future since it offers all the benefits of a CR mortgage but being at the same time much more flexible.

While savings rates compare closely or favourably with the mortgage rate, it seems best to keep my saving against the mortgage in a place where I can move the whole pot later if circumstances change - for example if we emerge from deflation into a period of high inflation, or I wish to protect these savings from loosing value due to a sterling devaluation event.

I wonder what will happen to savings rates during a deflation? Would they go up or down? Currently we can see that although the BOE has cut base rate, banks are still offering unchanged rates for savings - they obviously need our money. It is so hard to see how all this will pan out that the idea of locking myself and my repayments into a CR mortgage seems unwise...

CLAPTON

where do you see investments that will be suited to your purpose?

bleaky

CLAPTON wrote: »

where do you see investments that will be suited to your purpose?

Truth is I don't really know right now. I guess hard currencies (though which ones will turn out harder than sterling remains to be seen - best to use an expert managed fund for this than try and pick em I think), and possibly maybe some commodity index tracking funds.

Anything that goes up or even stays put while sterling slides in value would work for the purposes of paying off debt denominated in £. Trouble is finding aninvestment which has this attribute while also being reasonably safe.

During deflation I have even less idea what would be safest - probably just paying the debt down would work best. Depends on savings rates.

I just have bad a very feeling about our future wealth in this country relative to much of the rest of the world, and want to be in a position to protect my savings while hoping that perhaps my debt gets devalued while my ability to pay it down does not.