IO Mortgages and people's views

babyjp

I was at dinner with some friends the other night, we got on to buying property (as you do). We all own homes, I own a flat with my partner and some of them own houses. It was always a mystery to me how people could afford houses (especially in the part of London I live in). Anyway, it turns out that they all have IO mortgages, I have a repayment mortgage.

I questioned them as to how they planned to pay of the debt when their mortgage term came to an end. They all said that they didn't worry about it and they just worried about their needs now (i.e. having a big house for the kids etc.). They said that so much could change in terms of paying off the debt, one person said they could win the lottery?! Someone else said that property prices would go up so they could pay it off that way. But surely when they come to retire they would then have to sell their home to pay off the debt and hope they have enough left to buy somewhere else mortgage free?

I was really shocked at this. I suppose I'm far too cautious as I want to know that when I come to retire (a long way a way!) I have no mortgage to pay off.

They made me feel that I was far too cautious and that we should only worry about the "now". But this doesn't sit comfortably with me as it leaves my future far too uncertain.

Since then I've been reading lots on IO mortgages, particularly the forums on this website.

Apart from reduced monthly payments that then enable you to own a bigger property, what are the benefits of an IO mortgage? It worries me that some people don't have any plans in place to pay it off and I was really shocked by this, should I be?

dwsjarcmcd

IO mortgages are fine in certain circumstances but those all relate to when the borrower has a plan as to how, and when the capital is going to be repaid. The only other time is to allieviate a very short term problem such as a loss of job.

In the past, they could be used as you describe in a rising market to afford a bigger house, however, we are not in a rising market and it is unlikely we will be for some time. Even more, if your friends bought within the last 5 - 6 years, there is a fair chance they have lost money, or are in negative equit. This could make it very difficult to move home if they need to in the future.

Lenders are making it very difficult to get IO for the above reasons.

What people do is their own business but I think you are right and they are wrong. Anyone who thinks the lottery is going to save them, frankly needs to take a serious look at themselves.

I was going to say that IO is no different to renting but actually it is, or at least could be much worse as you are adding in the risk of HPI decreases which will leave you with the same debt but a lost deposit and then possibly negative equity which needs to be repaid.

Not a sensible course of action and not even a good short term strategy

opinions4u

While there are cases where interest only can meet a need, the scenario you describe is one of deferring disaster.

Your cautious approach is infinitely more sensible.

This board has had several threads in recent weeks where the op has described lenders being quite firm in expecting repayment at the end of an agreed term. But the borrower never made any arrangements to save in order to repay the debt.

I bet you have better pension arrangements than them too!

Locana

HI

Believe me I know. Mum is 61, and I recently found out she is on an interest only mortgage which ends in about 6 years. She has no way to pay off the mortgage - 91K (unless she wins the lottery, grrr). I'm so furious with her but she is refusing to talk about it. Luckily she has about 270K equity, but that still means probably selling the family home and downsizing. I'm upset as my Dad passed away last year and I'm annoyed that the 'family' home will inevitably be sold.

Humph.

Lo

Itismehonest

You're very sensible, OP.
It seems to be considered as rather old-fashioned to have a repayment mortgage.
An IO mortgage would, personally, have worried me to death.
I'm not sure whether they were even available when my mortgage was taken out.
IO payments were always something used when people fell on hard times & couldn't make the full monthly repayments.
Times have changed.

DVardysShadow

For younger people, it is almost inevitable that IO will be overtaken by a house price boom, several times over during a working lifetime of owning property.

As such, it is not a totally bad way of getting some equity. But it is a totally ineffective way of paying off the lending which you start out with.

Whether it is a short term measure to overcome job loss or it is a long term financial strategy, it requires an exit plan from the outset. And I think every time we see people in trouble with IO, it is because of a lack of an exit plan.

For a first property, if you can cope with negative equity and last in that property for long enough to see values rise, buying another property on a repayment basis is probably good enough as an exit plan, if you have enough years in the next property.

For a property in a high value area, simply down sizing gives a good exit - provided you are confident that the value differential will be maintained between where you are and where you will downsize to.

But on any property after the first, IO is not a good way to proceed. Having said that, Mrs Shadow and I are in the property we hope to leave feet first. And we have a small flexible mortgage on IO. We have paid about 60% off in less than 3 years, but we night re borrow within the original limits to do improvements. But always we are keeping in mind the need to pay that money off.

Thrugelmir

babyjp wrote: »

what are the benefits of an IO mortgage?

There's no benefits as such. Many were drawn into buying a larger property in the belief that rising house prices would enable them to "profit" at a later date.

Now that we are statistically all going to live longer then owning ones home. Really does pay dividends in later (retired) life.

There's a small % of people for whom making variable capital repayments is useful. . For the majority being "forced" to repay the capital in a disciplined manner is a necessity. As with human nature being what it is people are highly lightly to spend their money on other things or commitments.

The whole property boom needs to be looked at in the context of ever increasing amounts of available credit from the banks from the earlier 70's. Now after 40 years of uninterupted growth. We are going to have a decade or more of contraction. So there's a new game in play. Something which hasn't sunk in.

Highly recommend a book called the Ascent of Money (Niall Ferguson) a very easy read for non financial people or google "fractional reserve banking" to understand how banks created credit from nothing.

brit1234

I think interest only can be a good idea for short periods. Say you are on a repayment mortgage and your partner leaves work to give birth or you are made unemployed. However it should be seen as a temporary break only and you should jump back to repayment asap.

It seems suicidal all these property investors who do everything interest only, releasing any equity for further interest only properties. Or people stretching themselves as far as possible to get a home on interest only.

System

In reference to the OPs friends, they are part of a growing number of people in this country who effectively live beyond their means, in a similar way to people who live out of overdrafts or use the dreaded PDL companies. We get a lot of sob stories on the other forum boards, but people often get themselves into a mess because they dont take any responsibility for their money (OK, occasionally it isnt their fault, e.g. job loss etc and I do sympathise with these people). Trouble with a lot of people is they want, want, want now. So if you take a loan, you pay for it in the long run.

A mortgage is a debt and like any debt, the longer you have it, the more you pay for it. Personally I find that you often dont pay much more for a repayment mortgage than IO (obviously depending on the term). Personally I stretched myself and took out a 20 year term (as was only about £50/month more than 25 year term) and the thought of being mortgage free 5 years earlier is great. Twenty - twenty five years down the line when you are mortgage free and your friends owe 100s of thousands, you will be able to live in comfort and live in the 'now'. I don't think your friends will somehow.....

eh2nt

I think the OP's friends are going to be in for a big shock soon.

Recent FSA papers on interest only mortgages are encouraging lenders to make a check at least once (the FSA want more often) during the life time of the mortgage to ensure that the investment vehicle that the customers said they have is in fact there.

For those that do not have a vehicle (and i'm sure lenders will not be accepting sale of property / inheritance and lottery win as a suitable vehicle) they will be transferred on to a Capital & Interest repayment.

Remortgaging on similar IO is also going to be difficult as more and more lenders are now restricting IO and for those they agree are asking for proof of vehicle.

Clearly the later this is discovered for the ones without a vehicle the larger the monthly repayments are going to be.

hugheskevi

Apart from reduced monthly payments that then enable you to own a bigger property, what are the benefits of an IO mortgage?

Personally for me, the main advantage of IO is using a pension as the repayment vehicle, effectively getting higher rate tax relief on the mortgage repayments.

Another key benefit is flexibility, as overpayments can be made so that when there is extra income/capital it can be directed at the mortgage if that is appropriate. Therefore surplus income can be directed either at one-off expenditure, S+S ISAs, pension or mortgage overpayments at different times depending on what is the most appropriate vehicle for needs.

If you anticipate future income increases, and want to smooth living standards over time, IO would also have a useful role.

I've often found with financial products that it can be hard to separate the sophisticated from the reckless as they may well be using the same products. As an example, take credit cards - a high outstanding balance could be from financial incompetence, or from stoozing. Similarly gambling - someone spending lots on gambling could either be doing from ignorance and losing money, or taking advantage of arbitrage/matched betting. Same with IO - dangerous if no plan, but with a clear plan it may well be optimal.