Interest Only Mortgages

shortchanged_2

LilB wrote: »

We can afford the mortgage and more. Were you referring to myself as barely surviving? If so, it is not the case.

No I wasn't specifically aiming at you, I was speaking in general that in the past few years many people took out IO mortgages for affordability reasons seeing them as a cheaper way to get a house when it doesn't actually work like that.

Rikki

lea123e wrote: »

Luckily I am very disciplined with money and can afford to put away the overpayment money, and being aware that if i dont overpay i will still have all of the capital outstanding at the end of the term is more than enough motivation for me!
My main point was that having £100 per month extra which has been freed up by choosing IO, would be very useful and allow me to save those overpayments much more quickly than repayment.
Thank you for the useful contributions

Have you thought of having a part and part mortgage.

My mortgage is or was 50% repayment and 50% IO. I have repayment vehicle for the OI and still overpay each month but what ever I have spare each month.

SAMMYE_2

shortchanged wrote: »

No I wasn't specifically aiming at you, I was speaking in general that in the past few years many people took out IO mortgages for affordability reasons seeing them as a cheaper way to get a house when it doesn't actually work like that.

Agreed plus interest rates on Interest only mortgages are higher so your not saving money and if you can afford a repayment anyway you might as well go with a repayment mortgage.... if you really must do a interest only then fine but your not saving money by doing it that way in my opinion.

LilB_3

shortchanged wrote: »

No I wasn't specifically aiming at you, I was speaking in general that in the past few years many people took out IO mortgages for affordability reasons seeing them as a cheaper way to get a house when it doesn't actually work like that.

Cheers for clarifying, shortchanged

JimmyTheWig

lea123e wrote: »

I realise that i may be missing something huge here

Yes, you are missing something huge here.

With a repayment mortgage, each month you pay the interest plus extra to cover the repayment. You could see this as the equivalent of an interest only mortgage where you overpay each month.

For some people that's a good plan. E.g. if you can get more interest on your savings than you pay on your mortgage then interest only is worth considering.
But that doesn't sound like your case. You are wanting to reduce your monthly repayments to just the interest to be able to make overpayments.

I'm going to make a couple of assumptions...
1. You are disciplined and organised enough to make the overpayments with the difference you'll be saving each month
2. The bank will give you the same mortgage on the same terms whether it's repayment or interest-only.

Lets say you pay 5% interest on your mortgage and receive 3% (net) interest on your savings.
Lets say with interest-only you'd be paying £700 per month.
Lets say with a repayment you'd be paying £1000 per month.

If you go with the repayment mortgage, each month your balance is reducing by £300. The £300 paid in the first month will reduce your mortgage interest by 5% of £300 in a year.
If you go with the interest-only mortgage, each month your savings will grow by £300. The £300 saved in the first month will increase your savings interest by 3% of £300 in a year. At the end of the year when you come to make your overpayment, the interest earned will be less than the interest saved if you had had the repayment mortgage.

Also, you mention making overpayments of 10% a year. I presume that this is the maximum allowed. With a repayment mortgage, this 10% is on top of any repayments you make. With an interest only mortgage all of those £300s will count towards this 10% limit.

If you can afford a repayment mortgage and 10% overpayments, it might be worth shortening the term of the mortgage, therefore pushing the monthly repayments up. This will have the opposite effect to going interest-only which may be beneficial.


The exceptions to this may be if
1. You can get more (net) interest on your savings than you pay on your mortgage.
2. There is a minimum amount to an overpayment that you can make that you don't think that you would reach.

lea123e

Thanks for that Jimmy.

The interest rate on a few IO mortgages I have been looking at is currently 3.5% I currently get 5% interest net on savings.

Having looked at the overpayment calculator on here, using either repayment or IO, making overpayments of 10% has the mortgage payed off in 7 years.

JimmyTheWig

lea123e wrote: »

The interest rate on a few IO mortgages I have been looking at is currently 3.5% I currently get 5% interest net on savings.

In which case, if you think that you can be disciplined, then you may consider the following...

Don't ever pay anything off your mortgage!

Go interest-only and don't make any overpayments.
Put all the money you can into savings.
Either have a seperate account for this mortgage money or keep a proper record (e.g. backed-up spreadsheet) of what in your savings account is mortgage money.

Basically, your money is working harder for you earning 5% net in savings than saving you 3.5% on your mortgage.

But there are various reasons why you wouldn't want to do this...
* You might be tempted to spend (waste?) some of the mortgage money in savings while you wouldn't if it was paid off against your mortgage.
* You might lose track of what you've put into the mortgage savings pot.
* You might (as a MFW) be incentivised to see your mortgage balance reducing each year and so throw more money at it than you would if it was just a savings amount on a spreadsheet.
* There may be a limit on the amount of money you can put in savings at 5% net.
* Mortgage rates might go up; (your) savings rate might go down. To a point where you are paying more on your mortgage than you receive net on savings in which case it would be better to pay off the mortgage. Obviously at that point you could make an overpayment but if you're in a deal then you would be limited to the 10% per year.


My back-of-an-envelope calculations show you could knock about 6 months off your mortgage if you paid all the money into savings at 5% net rather than paid it all off the mortgage at 3.5%.

JimmyTheWig

Sorry to go on, but what i wanted to point out was that the bit you were missing in your first post was that (other than differences in interest rates which I have talked on at length) there really isn't any difference between an interest-only mortgage where you make overpayments and a repayment mortgage where you make slightly less (*) overpayments.
(*) slightly less overpayments accounts for the fact you can save less due to the higher monthly repayment.

lea123e

Many thanks again Jimmy for your valuable and informative illustration

Rikki

IO mortgages don't have a 10% annual overpayment limit. You can pay off as much or as little as you want, when you want.