Interest only or repayment?

chuckylefrek

Hi there

I would like some advice on what mortgage to choose. My partner and I would like to take out a mortgage of £130,000 which has been approved.

We are confused as to whether to take out an interest only mortgage or a repayment one. Basically with an interest only we would be paying nearly £200 less a month.

My feeling is that we should go for repayment as at least we will be paying off the mortgage however my partner feels that there is no real advantage to paying off any if say you sold the house after 3-5 years as it is mostly interest you are paying for the initial period of a repayment mortgage.

My head hurts thinking about all the mathematics so could do with some sensible advice.

Thanks

Paul

Joe_Bloggs

There is normally a repayment strategy behind an interest only mortgage. Contributions to endowments and other speculative investments are common and are expected to pay off the original capital on maturity.
Some interest only borrowers prefer to repay in cash when they have it to spare. They invent their own capital repayment strategy. At some stage the capital has to be repaid. If the interest only deal has an overpayment facility then by making £200+ extra payments you can create a repayment mortgage equal to the one offered. I have a 20 year repayment mortgage. With modest, penalty free, overpayments it will last 14 years.
The amount you wish to borrow is clear. The rates of interest, the term, your fees are not. A deposit can reduce the interest rate you pay and/or reduce fees charged by certain lenders.
J_B. (I am not a financial advisor)

dunstonh

If you go interest only you will owe the same at the end as you did at the beginning.

however my partner feels that there is no real advantage to paying off any if say you sold the house after 3-5 years as it is mostly interest you are paying for the initial period of a repayment mortgage.

Sure, the early years do not drop much. The balance drops in the shape of a curve with little early on and then speeding up to sharp drops in the later years.

However, if you dont start paying some of the balance of at the start, you will never get to stage where the balance starts dropping more quickly. Your partner has got the maths wrong. Both options you pay the interest. With the repayment mortgage that extra £200 each month is, in effect, coming off the balance each month. 5 years down the road, you would be more than £12,000 lower on the mortgage. Plus you would be paying off more off the capital than £200 because the interest is charged on the balance.

So actually going interest only would be the more expensive option as the interest payments over 5 years would be higher than a repayment mortgage.

If you sell the house after 3-5 years, what are you going to do next? Buy another one? rent? Assuming you are going to buy, thats another £12,000 needing to be borrowed or perhaps £12,000 less you can spend on buying a new house stopping you from moving up in quality.