Interest Only Vs Repayment

andrewmoorcroft

nrsql wrote: »

is it worth the effort?

OK. Here's a realistic example if you go the 'safe' cash ISA interest only mortgage route.

Assumptions;
Couple with £6K/year cash ISA allowance
£150K mortgage over 25 years.
Best rate mortgage circa 5%
Best rate ISA circa 6%

Saving £6K per year over 25 years = £150K
ISA value after 25 years = £171K (£21K better off than reapayment mortgage.
Alternatively - after 22 years your investment will be worth £150K. Just pay off your mortgage 3 years early and save £21K.

If we take a 'slightly risky' FTSE100 ISA route and assume a realistic 10% per year (never been that low over 25 years), your investment would be worth £300K after 25 years (£150K better off than repayment mortgage). Alternatively your investment would be worth £150K after 16 years so you could pay off your mortgage 9 years early.

Martinslovechild

Most 'endowments' sold during the 80's & 90's were invested in 'With Profits' funds; the fundamental problem with these is simply their lack of transparency, e.g. when the stock market has excellent years (2003-2007), returns from 'With Profits' funds have been extremely poor by comparison.

It's certainly more sensible to invest in FTSE Trackers or Unit Trusts rather than 'With Profits' - I would give these a wide berth (i.e. ignore altogether!).

In terms of risk, equities are proven to beat all other investments over a 10, 20 or 50 year term. Of course there are ups & downs - that's the nature of the market, but it's also the nature of the media. We tend to hear a lot more about 'stock market crashes' than we do 'stock market growth'. Anybody who invested money in the stock market in 2003 could have easily trebled their cash by now - the media hasn't said much about that simply because it's not news in itself. If a crash occurred tomorrow however, the media would be all over it like a rash.

In case you're wondering, the long-term average for equities is 12% per annum, compared to 9% per annum on property. Property is currently 36% above its long-term trend whereas stocks are nearing their average long-term P/E of 17 and are generally not overvalued.

andrewmoorcroft

The follow on...
I have a £70K mortgage and £70K in cash ISA's between me and wifey.
Our mortgage rate has always been lower than our savings rate (circa 1%). I moved my ISA's a couple of months ago to fixed rates in anticipation of the drop in interest rates but admit i never expected such a big drop. Soon i will have a 3% mortgage and 6.5% ISA savings (fixed for 2 years). I will be paying £2100 per year interest to earn £4550!
Mortgages are fantastic money making tools but the majority of people on this site are obsessed with paying it off and wasting a moneymaking opportunity!

I'm not mortgage free but my mortgage is free and making money!

jamesd

Free? It's a profit center! You need to make it bigger so you can make more money.

Dithering_Dad

When the 25 years is up and you come to repay your mortage, you'll lose the tax free status forever.

I see the sense in what you're saying, but I'd personally use the ISA allowance to build up tax free retirement savings than use them to repay my mortgage.

A good compromise would be to go interest only with the mortgage and build up ISA savings and pension savings (with the government contributing 20% or 40% tax rebate), then when you retire, use the 25% tax free lump sum from the pension to pay the bulk of the mortgage and some of the ISA savings to make up the difference.

With this method you will have effectively taken 25% tax free from your pension and put it straight into tax free ISAs. I'd imagine this is the most cost effective and tax effective way to pay off a mortgage. Plus you will have a really good mix of taxable and non-taxable pension money.

andrewmoorcroft

Dithering_Dad wrote: »

When the 25 years is up and you come to repay your mortage, you'll lose the tax free status forever.

I see the sense in what you're saying, but I'd personally use the ISA allowance to build up tax free retirement savings than use them to repay my mortgage.

A good compromise would be to go interest only with the mortgage and build up ISA savings and pension savings (with the government contributing 20% or 40% tax rebate), then when you retire, use the 25% tax free lump sum from the pension to pay the bulk of the mortgage and some of the ISA savings to make up the difference.

With this method you will have effectively taken 25% tax free from your pension and put it straight into tax free ISAs. I'd imagine this is the most cost effective and tax effective way to pay off a mortgage. Plus you will have a really good mix of taxable and non-taxable pension money.

I already pay the max pension i can and will get 40/60th's at the age of 55, yes, only 39 years paying into a scheme!
The way the ISA's are going so strongly (above my BOE base rate mortgage), i will be paying the mortgage with the interest from the ISA's and still have my ISA's left. My mortgage is interest only and i'm doing my own investment via ISA's that are paying more than my mortgage rate.
I went for a 30 year mortgage (ends when i'm 65) so i'll keep it going for as long as i can make a profit.

Dithering_Dad

andrewmoorcroft wrote: »

I already pay the max pension i can and will get 40/60th's at the age of 55, yes, only 39 years paying into a scheme!
The way the ISA's are going so strongly (above my BOE base rate mortgage), i will be paying the mortgage with the interest from the ISA's and still have my ISA's left. My mortgage is interest only and i'm doing my own investment via ISA's that are paying more than my mortgage rate.
I went for a 30 year mortgage (ends when i'm 65) so i'll keep it going for as long as i can make a profit.

The disadvantage of using your pension 100% for your retirement, rather than using a combination of ISA & Pension savings is that when you retire you will be taxed on your pension income (but not on any ISA income). Your estate will also lose most of the pension funds when you die and if you have a wife who doesn't have a pension you'll lose her tax free allowance.

When you turn 65, you get an age related tax free allowance of £10k. This reduces down dependant on your pension income (but not on your ISA income). Eventually, if your pension pays enough it will reduce back down to £5k - the single persons allowance.

The ideal screnario is to have enough pension savings (minus the 25% tax free lump sum) to take you upto the 10k per annum income, to have your wife do the same with her pension (so you have a joint tax free income of £20k) and then the rest of your retirement savings held in ISA savings, whose income is also tax free.

If I have £100k in my pension pot, £100k in my wife's pension pot and £200k in our combined ISA savings when we retire, we can use the 25% tax free lump sum from our pensions to pay off my mortgage (£50k). Use the remainder of our pension money to buy 2xannuities to the value of £9000pa (£75k x 2 x 6%) and have an additional income from our ISAs of £10,000pa (£200k x 5%). Plus our state pension of £6k x 2.

So a joint income of £31000, but a tax liability on just £500 of that income, so an annual tax bill of £100! Beautiful!!

Plus when one person dies, the other one still has the mortgage free house, the £200k ISA savings and their own state pension and personal pension.

It's not tax efficient to have a large pension pot soley in one partners name.

InMyDreams

This is what we've been doing too. Except I maybe missed a trick... We fixed our mortgage in Feb, thinking rates would rise, which they did to start with. We were laughing initially as most of our savings were variable. Oops! Frantically fixed as much as I could yesterday, and I think I got in in time, but the differentials are not going to be as much as I hoped for the next year. Only 1-1.5% for most of it (and only because we were very lucky fixing when we did). Still, as we've been doing this for nearly 3 years now, that 1% is now on quite a sizeable sum. I'm not sure this method would work for anyone trying to start now though.

Dithering_Dad wrote: »

Plus when one person dies, the other one still has the mortgage free house, the £200k ISA savings and their own state pension and personal pension.

Agree with all you say DD. Except I think when one person dies, the ISA shelter on their savings will be lost.

MrMicawber_2

What an excellent discussion. Given most folk probably aren't as wised up most of those contributing to this thread, wouldn't it be better to have the cast iron certainty of a repayment mortgage or at least part i-o part repayment and have a good balance between reducing your debt and saving / investing into ISA's and pensions. All things in moderation is a pretty useful maxim. I reckon there's an awful lot of people out there who are sitting on i-o mortgages which they've taken out because it allows them to get on the housing ladder or live in a more expensive house but who haven't thought at all about having to pay the loan off one day.

Getting shot of the mortgage really is a case of a bird in the hand being better than two in the bush, or it is for me. Once you'e paid it you are simply no longer dependant on investment or savings returns to ensure you still have the roof over your head.

Having said that I've been practicing what I preach which is trying to pay off the mortgage, plus put what I can into cash & stocks and shares ISA's and at the moment I'm lucky enough to be on a final salary pension but put a bit here and there into a SIPP.

Note - and this is probably obvious but a risk of stocks and shares ISA's is of course if the bottom falls out just when you want to repay your mortgage so then lifestyling comes in which will reduce the overall return somewhat.

andrewmoorcroft - just out of interest how do you know you will get a 40/60 pension when you are 55. Public sector final salary I would understand. Personal pension and where's the guarantee?

andrewmoorcroft

MrMicawber wrote: »

andrewmoorcroft - just out of interest how do you know you will get a 40/60 pension when you are 55. Public sector final salary I would understand. Personal pension and where's the guarantee?

I started paying into a company final salary scheme at the age of 16. After 40 years you would normally reach 40/60. However there was a rule change (think 1989) that meant i only have to pay for 39 years. I dont fully understand to be honest but my pension statement mentions it. I do understand that if i pay AVC's and work for 39 years, i still cant take more than 40/60 so paying past 39 years doesnt gain me anything and my AVC's would be returned minus tax.
I dont know for definite that the company will let me go at 55. I'm hoping for VR!