intersest only mortgages ....verus standard .

Ian_W

jamesd wrote:

HelpWhereICan, it appears that you're counting the interest twice. The reduced balance on the repayment mortgage already includes the interest saved on it through the repayments.

I don't think that is right james. The reduced balance reflects the capital you owe if you were to pay it off to-morrow and because that is reducing you're not paying interest on the full £100k for the full term of the mortgage like you are on IO.

Using HWIC's figures for the whole of the mortgage on repayment you end up paying in total £184,927 with the principal sum fully repaid. On Interest Only the interest over 25yrs is £138,130 but you've also got to repay the £100k you first borrowed, making the total difference £ 53,203 more on IO. Using your future values calculator the £156pm difference between IO and repayment, if it's invested and returns a cautious 7% makes you the princely sum of £128,001 - more than enough to pay off the capital you initially borrowed BUT you've paid over £50K more for the privilege of gaining £28K. So would need a far less cautious average return over 25yrs of 8+% to win.

Of course you can fart and faff about with the % interest rates all you want and use any amount of future values calculators but none of us can see into the future and *know* what mortgage rates or market returns will be over 25yrs. You can, however, be sure that if you take out a repayment mortgage, it will pay off what is most peoples biggest personal debt liability at the end of the term.

But I said in an earlier post that there are savvy investors who can use this method and actually win. You may well be one of them - but borrowing a huge amount to buy a property has inherent risks of it's own so pretending - OR WORSE STILL actually believing - that doing so and using savings/investments to repay the money borrowed doesn't add further to those risks is denial personified!

However, to go back to the OP's point - HWIC's post illustrates that it is rubbish to suggest that a repayment mortgage doesn't repay the mortgage in the early years, 25% of the loan is repaid by year 10. Also note that the OP didn't suggest IO + savings/investment, it was IO cos it's cheaper and you don't any of the capital off in the early years.

jamesd

Ian W, interest calculations are fully reversible - that is, if you repay it or save it, the numbers have to end up the same. It's impossible for HelpWhereICan's calculation to be correct because the numbers for repaying and saving the 155.99 don't match.

Why care about paying 50000 more in interest when you've made 78000 in interest? You're still 28000 better off and your monthly payments haven't changed.

You don't need to be a great or risky investor to use a cash ISA and even that at just a quarter of a percent difference took six months off the mortgage. That 5.75% one is effectively no longer available though, since it now requires 15,000 minimum in the ISA. Off to the regular savers for a year or two and repeat as necessary if you want complete safety.

Agreed about needing some repayment method, or at least knowing that you're just paying rent and hoping for house price growth to make you a profit.

tenpin369

My understanding is that 'interest only' is only available if you have (substantial) equity on the property. An unlikely scenario for a FTB. Also the penalties at the end of the IO period are considerable.

Or am I with the wrong provider?
2 years @ 2.1%

HelpWhereIcan

Ok. Apologies for the length of what is about to follow.

james, I understand where you are getting your figures from and how you have interpreted them.

The figures I have given for the total amount of interest payable over 10 and 25 years are accurate. As I have said, do not underestimate the compound effect that paying interest on a reducing balance has.

Perhaps it would be useful for me to illustrate my point in a slightly different way.

Let’s assume that I buy a house for £117,000. I put in a £17,000 deposit and borrow £100,000.

Monthly payments for my mortgage assuming a rate of 5.49% would be:

£457.50 on interest only, or
£613.49 on repayment.
A difference of £155.99 pm

I assume that, invested, the £155.99 pm will attract an average of 5.75% (net) return and that it will be worth:

£ 25,340 in 10 years time, and
£ 104,533 in 25 years time.

I assume that the value of the house will grow by an average of 5% and that it will be worth:

£192,700 in 10 years time, and
£407,310 in 25 years time.

(I have used your future value calculator to get these figures)

I now have to make the decision whether I want to put my mortgage on repayment or interest only, investing the difference to hopefully maximize the gain I make.

I decide that my decision will be based on the ‘net profit’ that could be made compared to the risk that I have to take to make it. In other words, what will I end up with in terms of cash when I sell the property in either 10 or 25 years time, and how much will I have paid in interest on the mortgage to accumulate that cash.

The 10 year point looks like this:

Interest Only

I sell the house for £192,700
My mortgage balance stands at £100,000
Which gives me equity of £92,700
My £155.99 pm attracting 5.75% pa has grown to be worth £24,340
I therefore have cash to put in the bank of £117,040

Over the 10 years, I have paid Interest on the mortgage of £54,900
Which gives a ‘net profit’ of £62,140

Repayment

I sell the house for £192,700
My mortgage balance stands at £75,131
Which gives me equity of £117,659
I have not been investing monthly so have nothing in savings £0
I therefore have cash to put in the bank of £117,659

Over the 10 years, I have paid Interest on the mortgage of £48,750
Which gives a ‘net profit’ of £68,909

I have therefore ‘made’ £6,769 more by being on repayment without taking the risk on investment performance, taxation and time taken to actively manage my investment.

The 25 year point looks like this:

Interest Only

I sell the house for £407,310
My mortgage balance stands at £100,000
Which gives me equity of £307,310
My £155.99 pm attracting 5.75% pa has grown to be worth £104,533
I therefore have cash to put in the bank of £411,843

Over the 25 years, I have paid Interest on the mortgage of £137,250
Which gives a ‘net profit’ of £274,593

Repayment

I sell the house for £407,310
My mortgage balance stands at £0
Which gives me equity of £407,310
I have not been investing monthly so have nothing in savings £0
I therefore have cash to put in the bank of £407,310

Over the 25 years, I have paid Interest on the mortgage of £84,047
Which gives a ‘net profit’ of £323,263

I have therefore ‘made’ £48,670 more by being on repayment without taking the risk on investment performance, taxation and time taken to actively manage my investment.

While my calculations before may have been (for ease’s sake) more simplistic, the premise remains the same.

The figures for the balance and interest payable can be seen in the following linked pdf documents (unable to upload the actual documents). These have been generated by the same software that generates KFI documents and will be accurate as far as the FSA etc will be concerned.

Interest Only and Repayment

Look at the “Total interest charged to date” and “Remaining debt” columns for the relevant figures.

I am not looking for a protracted debate on the matter and accept many of the points you make, but have to reiterate that the compound effect of interest being charged on a reducing balance is often overlooked.

When endowment mortgages were at their peak, firms would often only look at the rate required to build up enough to pay off the mortgage. In this case £100,000 so they would say “as long as it makes the £100,000, any extra is a profit”. In my opinion, this is flawed as it ignores the fact that an interest only mortgage pays more in interest as the balance on which you are being charged interest stays the same; whereas the balance on which you are being charged interest on a repayment mortgage reduces. The importance of this effect is now greater as most mortgages have daily interest as opposed to the annual interest mortgages of old.

That is why, in these times of low inflation, low interest rates and low investment returns, I am unlikely to get back to the point where I feel it represents good value when comparing risk and reward to reccomend most people do other than a repayment mortgage for some time.

dwsjarcmcd

tenpin369 wrote:

My understanding is that 'interest only' is only available if you have (substantial) equity on the property. An unlikely scenario for a FTB. Also the penalties at the end of the IO period are considerable.

Or am I with the wrong provider?
2 years @ 2.1%

tenpin
Yes you are wrong on both counts. I suspect your deal has overhangs i.e. charges that go beyond the end of the deal. It makes no difference whether your IO or C & I

InMyDreams

HelpWhereIcan wrote:

As I have said, do not underestimate the compound effect that paying interest on a reducing balance has.

Yes, it's exactly the same as the compound effect that earning interest has on an increasing balance.

HelpWhereIcan wrote:

Interest Only

I sell the house for £407,310
My mortgage balance stands at £100,000
Which gives me equity of £307,310
My £155.99 pm attracting 5.75% pa has grown to be worth £104,533
I therefore have cash to put in the bank of £411,843

Over the 25 years, I have paid Interest on the mortgage of £137,250
Which gives a ‘net profit’ of £274,593

Repayment

I sell the house for £407,310
My mortgage balance stands at £0
Which gives me equity of £407,310
I have not been investing monthly so have nothing in savings £0
I therefore have cash to put in the bank of £407,310

Over the 25 years, I have paid Interest on the mortgage of £84,047
Which gives a ‘net profit’ of £323,263

I have therefore ‘made’ £48,670 more by being on repayment without taking the risk on investment performance, taxation and time taken to actively manage my investment.

While my calculations before may have been (for ease’s sake) more simplistic, the premise remains the same.

I agree with james... you are counting the interest paid twice to get your notional 'net profit'. Or doing something funny, anyway. Surely the 'net profit' ought to be the full amount banked, less your original deposit which was the same in both cases. If I was to sell the house and have a choice between banking £407,310 or £411,843, I know which I'd prefer to do and you're not going to convince me that I'd be better off with £407,310! And this is with only a quater of a % difference. I may have paid loads more interest on the mortgage, but what I've earned on the savings is even greater still.

HelpWhereIcan

InMyDreams wrote:

Yes, it's exactly the same as the compound effect that earning interest has on an increasing balance. .

But you are not comparing like with like. You ignore the fact that the interest only mortgage has a constant balance so you pay £5490 in interest in the first year and £ 5490 in interest in the last year and every year in between. T

InMyDreams wrote:

I agree with james... you are counting the interest paid twice to get your notional 'net profit'. Or doing something funny, anyway

If you don't agree with my figures or believe the repayment schedules I have produced, use any amortization calculator such as http://www.hsh.com/calc-amort.html to produce your own figures for the interest paid and remaining balance in each year.

InMyDreams wrote:

Surely the 'net profit' ought to be the full amount banked, less your original deposit which was the same in both cases. If I was to sell the house and have a choice between banking £407,310 or £411,843, I know which I'd prefer to do and you're not going to convince me that I'd be better off with £407,310! And this is with only a quater of a % difference. I may have paid loads more interest on the mortgage, but what I've earned on the savings is even greater still.

But to get the 411,843 you have paid 5490 x 25 = £137,250 in interest.

To get the 407,310, you have paid £84,047 in interest (use whichever amortization calculator you like)


I know which I would prefer

Ian_W

jamesd wrote:

Why care about paying 50000 more in interest when you've made 78000 in interest? You're still 28000 better off and your monthly payments haven't changed.

No james, you'd actually be about £22K worse off as the £78,000 interest plus your savings amount to about £128K BUT you've still to repay the £100k borrowed. So you've paid £50K more to gain a £28K "profit" - funny moneysaving to me!!
And that's assuming 7% net growth on your savings. The only way that will be sustained IMO is in the stock market which carries risks as we saw as recently as 2002/3. Monthly savers appeared only 2yrs ago and their purpose is to gain the banks your current account - whose to say they won't disappear just as quickly? In any case they're time limited so your money will go to a lower rate after 12/24 months and the best ISA and taxed accounts are only around 5.5% - marginally above the mortgage rate.

InMyDreams wrote:

I agree with james... you are counting the interest paid twice to get your notional 'net profit'. Or doing something funny, anyway. Surely the 'net profit' ought to be the full amount banked, less your original deposit which was the same in both cases. If I was to sell the house and have a choice between banking £407,310 or £411,843, I know which I'd prefer to do and you're not going to convince me that I'd be better off with £407,310! And this is with only a quater of a % difference. I may have paid loads more interest on the mortgage, but what I've earned on the savings is even greater still.

There isn't any double counting at all or funny business, I've no interest whatsoever in whether you, james or anyone else goes IO on your mortgage - your choice.
But go on any of the bank, bs or comparison sites and do the figures yourself. On the face of it a repayment costs more but when you add in the sum borrowed [which still has to be repaid on IO] to the interest paid on IO it becomes much more expensive. Unless the difference in monthly payments returns in excess 8% year on year for the whole 25yrs, it's a loser.
If you're saying you'd rather pay nearly £1000 a year more for 25yrs to bank £4K more at the end - that's even funnier moneysaving!! :rolleyes:

By the way - I've got this smashing new wheeze to do it cheaper still - it's called endowments, you pay me a couple of hundred quid a month for the next 25yrs, I'll invest it in the stock market and you'll pay off your mortgage and be rolling in it - it's not guaranteed - but you know you can trust me!

InMyDreams

HelpWhereIcan wrote:

But you are not comparing like with like. You ignore the fact that the interest only mortgage has a constant balance so you pay £5490 in interest in the first year and £ 5490 in interest in the last year and every year in between. T

No, I'm not. See below.

HelpWhereIcan wrote:

If you don't agree with my figures or believe the repayment schedules I have produced, use any amortization calculator such as http://www.hsh.com/calc-amort.html to produce your own figures for the interest paid and remaining balance in each year.

I agree with your figures, right up until you go and subtract the interest paid at the end.

HelpWhereIcan wrote:

But to get the 411,843 you have paid 5490 x 25 = £137,250 in interest.

To get the 407,310, you have paid £84,047 in interest (use whichever amortization calculator you like)

I know which I would prefer

So? Don't care how I've done it, I have more in the bank at the end of the day. The extra I've paid in interest has been more than made up for by the interest I've made on the savings. Which can clearly be seen by the end bank balance! Both methods are based on exactly the same monthly payment.

Ian_W wrote:

If you're saying you'd rather pay nearly £1000 a year more for 25yrs to bank £4K more at the end - that's even funnier moneysaving!!

But I'm not paying any more than HWIC! It's just that instead of paying the capital off, I'm paying into a savings account. The monthly payments are exactly the same! On repayment they are £613.49, of which the proportion of interest to capital repayment changes over the term. On IO, they are £457.50 on interest (which granted, doesn't decrease) and £155.99 into the saving account. Yes, this £155.99 doesn't increase either, but as HWIC says, "do not underestimate the compound effect" which now is working the other way.

Ultimately, both methods equate to me paying £613.49 pcm for 25 years, but with one I have £407,310 at the end of the day and with the other, £411,843.

tomstickland

I've looked in the mortgage maths before.
If you go IO and work the money not spent on the mortgage at the same rate as the mortgage then it'll make no difference. If it returns more than the mortgage then you gain, less and you lose.

If you look at the mortgage/loan equation then you can split a mortgage into two bits:
-a loan that accrues interest over the term
-a savings account that receives payments and accrues interest
at the end the two balance out.