Interest only or repayment?

fimonkey

If for example,

a repayment mortgage at 5.5% fixed for 3 years was £650pm,
whereas an interest only was £550pm,

Would I need to be looking to put the difference of £100pm into an investment that pays 5.5% net to be able to match the repayment mortgage? Is that how it works??

If I go for an interest only, would I have to show that I'm also saving elsewhere to repay the capital?

(I'm a soon to be FTb, and the whole 'interest only Vs repayment is confusing me).

Scaredy_Cat_3

I used to work for a mortgage lender, but my info may be a bit out of date. If you have an interest only mortgage you are advised to take out some kind of policy to pay the mortgage off at the end of the term, but it's not compulsory. I have known some people who took out interest only mortgages because it works out cheaper that way on a monthly basis, but you must bear in mind after, say, 25 years you will still owe exactly the same amount. You could sell up at that point and use the money from the sale to clear the mortgage, but personally I don't think that's a particularly good option. Where I worked they took the position that while they recommended you having a policy to support the mortgage, the onus was on you to make sure you did, i.e. they would not insist on seeing evidence.

I don't think you can get a policy which will guarantee to pay out at a specific interest rate, as you suggest. My endowment policy, for example, is guaranteed to pay out a certain amount if I die, but otherwise the amount it will pay out on maturity (after 25 years) depends on the performance of the policy. I get annual statements showing how much I will get on maturity if the growth rate is 4%, 6% or 8% - but there's no guarantee what the actual rate of growth will be. It's basically a gamble (wish I had been told this when they sold me the policy - but you live and learn!).

It's your decision, but personally I wouldn't consider interest only unless you are planning to do the place up and sell it on, using the money from the sale to clear the mortgage after a relatively short time. If you're in it for the long term, I would personally prefer the security of repayment so at least you know you are reducing your debt. No doubt others will disagree, it's got to be your decision, based on your own attitude to risk.

Good Luck!

fimonkey

Much apprecaited, and more opinions welcome please!

I'm thinking that I can afford to buy a freehold for 150K with a 25K deposit IF I go for interest only, with the proviso that I won't be staying there for 25 years (who does nowadays) and after 3 years I would re-mortgage (onto a repayment hopefully - or move house even).

1. If I take out an endowment, does it HAVE to be for the whole term of the original mortgae, and what hapens if I then move and go to a repayment mortgage?

2. What are 'endowments' and what alternatives are there for putting money away if on an interest only mortgage?

However if I go for repayment at this stage, then I can pnly afford £130K property which in east Dorset means a leasehold flat.

Scaredy_Cat_3

Forgot to say, my endowment policy is currently under-performing (along with all the rest!) so that has coloured my opinion of endowment policies and their promise to repay your mortgage! When they sold us the endowment we were also given quotes for an interest only mortgage with an endowment vs a repayment mortgage, and the monthly figures came out the same (to within a £) - but they forgot to mention that interest only is a complete gamble.

If I had known then what I know now...

Scaredy_Cat_3

I don't think an endowment policy has to be for the whole term of the mortgage, you can set it at whatever term you choose, but I think generally the longer term the more chance of a good return.

If you are planning to move on and/or switch to repayment in the next few years then I don't see why you shouldn't go with interest only and not bother to take out any policy at this stage - as long as you don't forget what your plan is! I would normally say you should take out some kind of life insurance - but even that isn't necessary unless you have a partner or children who would be in trouble if the worst should happen.

An endowment policy is basically a life insurance policy - it guarantees a lump sum if you die, and an indeterminate sum if you live. That sum, as I said earlier, depends on the stock market growth over the term. Sorry, I don't know about alternatives such as ISAs, but I'm sure there will be others along soon who can help there.

In your situation I think it makes sense to do as you suggest and just go with interest only for the first few years - as long as you don't continue that way indefinitely (although if you did, and I have seen mortgages where people do, you could simply sell up at the end of the term and pay the mortgage off with the proceeds).

ohmsoft

Hi

Please bear in mind that when you convert to repayment in a few years time the repayment will be higher as the term will be shorter (also consider that interest rates may be quite different - are you confident that your affordibity will be better further down the line? With caution in mind converting to repayment at a later date is a viable option, indeed some lenders offer it as a product in its own right.

Qualifying endowment policys offer certain tax benifiets on the investment proceeds within it - this operates in a similar way to ISA's although these do not contain the life cover and you are limited to the amount you can invest per year. In limited circumstances a pensions lump sum could be suitable to repay an interest only mortgage and failing that any investment....the real risky options are relying on inheritance or an increased property marketing (downsize and repay with equity).

I'd get myself to an IFA if I were you becuase there are real risks on the above - repayment is a much safer option

fimonkey

Thanks ohmsoft, ... I would convert to a repayment in 3 years time but re-mortgage for a full 25years, so the term will be the same as now (if I go for an interest only it doesn't matter if it's 25 or 30yrs, so will set it at 25yrs). With that in mind, won't the repayments be less?

Also in 3 yrs time, my salary will have increased (albeit in line with inflation, nothing major) but this will give me the extra ££ needed to cover repayments. Sound like a good plan?

Finally, excuse my thickness, but if I buy now for £150K, then re-mortgage in 3 yrs time, it will still only be for the 150K right? (not the value of the house as it may be in 3 yrs time, either higher or lower)?

(I personally think leaseholds are more trouble than their worth, ground rent/maintenance charge/buildings insurance you don't have chance to shop around for, and you don't even own the place! Given the difference of 20K to be able to stretch to a freehold, albeit on an interest only mortgae, wouldn't you??)

Leon_W

I think interest only mortgages get stigmatised and are always seen as the worlds worst mortgage option. This isn't the case. In specific circumstances they can provide all sorts of different answers to mortgage problems and as long as you realise that the capital is not being reduced then where is the problem ?

Most lenders will allow you to overpay within the ERC period without penalty anyway so you could take an interest only mortgage and overpay on it if you wish (effectively a repayment mortgage) or not as your circumstances dictate. Generally a much more flexible option than a straightforward repayment.

fimonkey

WOW, thanks Leon, didn't know that! I'm going to see a MA this afternoon for an informal chat, anything else I should be asking of him/be aware of etc etc?

Cheers

[Deleted User]

Its a bad idea as most people spend to their means, so the extra 100 simoleans you save will be spent on cookies and lattes. The difference between interest only and repayment is fairly small but it can litterally save you hundred of thousands of pounds in interest payments in the long term if you ever want to own the place.

A bit harder in the short term but in the long term it pays dividends. So id say only do it as an absolute last resort and if renting is cheaper tehn interest only go renting.

Leon_W

Yant.

If you were in a position to buy a house 10 years ago for £60,000 with a £50,000 interest only mortgage or rent which would you have done ?

I know hindsights a wonderful thing and all that but ..........

I do agree with one thing however. You need to be disciplined to overpay on an interest only loan because there is always that temptation to just make hay while the sun shines.

I personally have always had interest only loans. Before I got married we both used to overpay, we then got married and backed the payment down to only the interest only amount (pay for the wedding), overpayed again for a bit until my wife had our daughter, interest only for a bit (and some !), now she's at school we're overpaying again.

Peoples lifestyles change all the time and what is suitable now may not be in just a couple of years. How many times have I read on this forum that someones partner has left them or suddenly there's an unexpected child on the way and only one income coming in ?? Invariably the advice if someone is struggling is to ask the lender to just pay the interest only ! This is not always granted. What do you do then ? If your on an interest only loan to start with there is no need to go cap in hand to the lender as you can just pay the minimum.

As I say, that's how I've always done it but I'm not advocating that it is the right course for anyone else. My choice alone.