Mortgage Advice Required

mayya_hiremath

Hi,

I need some inputs as to the advantages/disadvantages of going for a Interest Only Mortgage or a Repayment Mortgage.

I need the inputs so that I can arrive at a conclusion as to which type of the two is most efficient.

For info - I am a freelance IT contractor; I am planning to buy my first house which will be my permanent place of residence;I intend to mortgage for a period of 25 years;I intend to take up a flexible mortgage which will allow me to make extra payments. I intend to stay in the U.K for the next 6-7 years and following that sell the house and return back to India.

Appreciate any help in this regard.

Thanks,
Mahesh

herbiesjp

If you are looking at staying short term then I would suggest looking at interest only. The reason being is that you do not intend to own the property outright but rather own it while yo are here and then sell up and move back to India.

Having an interest only mortgage, and making overpayments, is in effect a do it yourself repayment mortgage. By making the overpayments you are reducing the cpaital outstanding, so that when you do come to sell, the amount owed to the lender will be less, and therefore more of the proceeds from the sale will be yours.

Hope this helps.

Fairdo_2

I'd agree with herbisjp in that, if you are very likely to go to India, if you are selling then and not planning to come back, then there would be little point in going for a Repayment mortgage. This is because you would effectively be front-loading some of your future interest payments on a traditional mortgage, when you may not be here to benefit from the fact that more capital is taken later on.

Are you planning to return back to the UK at some point? Are you wanting to sell up and sever your links with the UK for good?

If you are, then I would suggest that, whilst you can afford to, I would look at the comparison costs against a Repayment mortgage and overpay by that amount of difference (between Interest Only and Repayment) as a bare minimum, as you would then start building up your equity early on.

Obviously, you would need to get advice on the best product for you, especially making sure that you have the flexibility to make these overpayments without a penalty.

mayya_hiremath

Hi,
That was very handy info and I especially appreciate both of you guys' way of explaining things in a simple but clear way!

Just another quick one - supposing I take up an interest only mortgage,can I switch from this to a repayment mortgage ? or Vice Versa

Thanks Again,
Mahesh

herbiesjp

Yes you can change when you want - just call the lender to do so.

Fairdo_2

Depending on lender, you can be subject to nominal administration charge for doing so, but as herbiesjp says, it can be done at any time.

payless

Fairdo wrote:

This is because you would effectively be front-loading some of your future interest payments on a traditional mortgage, when you may not be here to benefit from the fact that more capital is taken later on.

What do you mean my this?

Fairdo_2

On a Capital & Interest mortgage on a traditional basis, an assumption is made that the loan will be taken out for a specified number of years (usually minimum 5 years). From this, the lender applies a formula that a portion of the Repayment is taken as Capital Repayment and the other part is on a payment of Interest due.

In the early stages, less Capital is taken than Interest and later on in the mortgage, more of the premium is taken as remaining Capital Repayment and less is taken as an Interest payment.

Obviously, as less Capital is outstanding less Interest needs to be charged from that assumed same premium. Therefore, more capital can be taken from this premium.

mayya_hiremath

I have also been suggested to consider an Interest Only-Offset Mortgage . I am enquiring on this with a few lenders that I know of, but by any chance, would anybody know any lender who has this option, considering the fact that I have been into contracting only for the last 3 months (hence do not have the 1 year's audited accounts).

payless

Fairdo-
happy about the formula and varying split capital/ interest of a repayment mortgage

However why this would be a reason to benefit an interest only ?
( oK on some annual rest products there may be an element) but on a more common daily calculation ) surely the payment split represents the true situation
ie some capital reduction and some interest.

The extra costs of a repayment mortgage is totally reflected in the capital repaid off at the end of each year ( in fact the amount paid off is "increased" by the interest rate)

For example ( taken from a random file)

£198K 25 yr at 5.5%

Int only 1 yr = £10890
Repay = £14590 (ie £308pm more)

( means paid out £3700 extra over the yr)
Capital reduction £3800

The £308pm "invested in the repayment " at 5.5% pa interest would also produce same the £100 interest

( rounded to make more readable)


--
For many years it was suggested by certain advisers that it was wrong to take a repayment mtg, as "little or nothing is repaid in the early years"
I do think that this was used a way of encouraging endowment sales


Not saying that in cashflow terms an interest only mortgage is not something the OP could consider- just that certain myths seem to carry on

--
Another spin on my thoughts ( edited/ lifted partly from Motley Fool)
Repayment Mortgages

With a repayment mortgage, the borrower pays an amount on top of the monthly interest which goes to repaying the capital, since the capital reduces every month, so does the interest payment. As a result, every month, the borrower can repay a bit more capital than he did in the previous month. This means that in the next month even less interest needs to be paid and even more capital can be repaid. In the early years, very little capital is repaid but, towards the end of the loan, the amount of capital being repaid each month sort of "snowballs". So, halfway through the mortgage, much less than half of the capital will be repaid. There is nothing bad about this, it's just the effect of borrowing money. You can think of it being rather like compound interest in reverse

Fairdo_2

Thanks payless. I particularly like the extract you lifted. It succinctly describes the situation and my understanding of how th ebalance reduces.

I was assuming traditional annual rest mortgages and must admit when I have done the calculations, it seemed to be better to overpay an an Interest Only basis for a short term methos of reducing the capital quicker. However, I will go back to the books and look again.

Thank you for the explanation.