Interest Only Vs Repayment

andrewmoorcroft

ManAtHome wrote: »

Out of interest, do lenders (have to) assume a rate of return on investment - you could lend a more by using 10% instead of 5% for example.

Not sure what you mean. The amount a society lends has little to do with their rate of return on their investment (ie; interest on your loan). It has little to do with any investment that you subsequently make to try and pay off your loan. It has everything to do with your ability to pay the loan. When interest rates were higher (20 years ago) many societies lent based on lower income multipliers than they use these days (now the interest rates are lower). The bigger multipliers 'may' be a combination of both lower interest rates and societies pushing more risky affordability levels to allow people to buy at todays high market prices.

CharleneUK

We've opted for an interest only with the idea to pay the remainder into a high interest account. Now I'm worried this was a mistake!!

andrewmoorcroft

CharleneUK wrote: »

We've opted for an interest only with the idea to pay the remainder into a high interest account. Now I'm worried this was a mistake!!

Why a mistake?
As long as the net interest on your investment exceeds your mortgage interest rate you are quids in!
As far as i'm concerned an interest only mortgage is a very flexible DIY repayment mortgage. Ie; you are totally in control of the repayment part.

andrewmoorcroft

Conor wrote: »

An Interest only one is basically an endowment mortgage and we all know how they worked out.

Sorry but you are wrong! You can use any investment you like, even planned inheritance to pay off your capital.

Conor wrote: »

Saving the capital portion works really well until something happens such as more kids or unemployment and all of a sudden, the temptation to dip into that large pot of money you have there becomes too much.

Any loan or investment requires discipline. You don't save the capital portion, you save / invest with the plan that one day you have enough to pay off the capital loan - i'm sure this is what you meant!

ManAtHome

Didn't think it was that obscure, but ok:

Presumably interest-only "affordability" should include both the interest payments and my payments into any other investment designed to repay the capital.

If "mr lender" believes I can afford £1000 a month, he must therefore be apportioning this between interest payments and my own investments.

If he assumes that £200 per month at 5% will repay the capital, he can offer me a loan/mortgage for which I will £800 per month in interest.

If he assumes that £100 per month at 10% will repay the capital, he can offer me a loan/mortgage for which I will pay £900 per month in interest.

So he must be making some assumption about growth of any investment I am hoping will eventually repay the capital? To go to a ludicrous extreme, if he assumes that £100 Premium Bond will win enough to repay, he could offer me an "affordable" loan with interest payments of £1000 a month.

From looking at many threads on MSE, I don't get the impression that the "mr lenders" really give a hoot what customers have in place to repay the capital - their "affordability" test seems to relate entirely to interest repayments.

andrewmoorcroft

ManAtHome
You may be trying to put too much logic into the equation. Lenders use the same income multipliers to calculate how much they will lend you whether you have a repayment or interest only mortgage. This may be on the basis that they cost the same at zero investment risk so are equally affordable (or not)!

Having got an interest only mortgage you have to decide what is the best cost v's risk investment for you. Many go for the cash ISA approach but you'd be lucky to beat you mortgage rate by more than 0.5%. A tiny bit more risky would be the shares ISA route which would typically beat your mortgage rate by 7%. Eg; top 100 index – mortgage = 12.5% - 5.5% = 7%. This is the idea behind what endowments should have done but excessive set up, management and insurance fees made them perform at less than 6% net whilst the top 100 index returns were 12-15%! Criminal!! Read https://www.fool.co.uk for more info.

If you went into to branch and explained your fantastic investment scheme it will make little difference to how much they'll lend you.

ManAtHome

andrewmoorcroft wrote: »

ManAtHome
You may be trying to put too much logic into the equation.

Quite likely, thanks for the response Andrew.

benood

andrewmoorcroft wrote: »

A tiny bit more risky would be the shares ISA route

This is a little sanguine I think. Although I have an interest only mortgage and equity ISA's I would describe the approach as a lot more risky than a cash ISA although over 10+ years you should expect to be better off.

You have to be prepared to take the rough with the smooth - over the last 10 years my investments have shown average annual returns between -20%:eek: (to March 2003) and +13.5%:D (to now). If you don't have the stomach to see 30% wiped off the value in a few months you might be better off with a repayment mortgage or a cash ISA.

andrewmoorcroft

benood wrote: »

This is a little sanguine I think. Although I have an interest only mortgage and equity ISA's I would describe the approach as a lot more risky than a cash ISA although over 10+ years you should expect to be better off.

I agree that a FTSE 100 index ISA is slightly more risky than cash, but what is a safer investment that significantly beats cash invetments? Most mortgages last more than 10 years though, and over any 20 year period the FTSE 100 would have beat the best cash investment 99% of the time. I think i'll take the 1% risk rather than take the 99% certainty that i'll beat an interest only mortgage + cash ISA. I'll definitely take the 99.9% certainty that an interest only + FTSE 100 index ISA will beat a repayment mortgage.

nrsql

>> I would describe the approach as a lot more risky than a cash ISA although over 10+ years you should expect to be better off.

Maybe, maybe not - that's the risk you are taking.

>> I am a bit confused here. Everyone advise to have a repayment mortgage.But isn't it better to have an interest only one and
1.> save the difference between the two into a current account with good interest
2.> Every year reduce the mortgage capital by paying from the above savings.

Most mortgages calculate interest daily on the balance so by doing ths you are accruing more interest. If you get a higher interst on the savings after tax than the mortgage rate (only tax free products probably) then it will profit - but very little probably, is it worth the effort?
An option is to take an interest only mortgage and let inflation decrease the value of the balance (risk) and start paying it off later when you can afford it (risk).