The Interest Only option

cooper9

Hi,

My partner and I are about to buy our first house together. My dad, who has been a lot of experience in buying and selling property for 30 years, is strongly recommending interest only instead of repayment. His aregument is that if I buy a 250k property now, in 25 years time, it will be worth a great deal more than 250k. For the sake of argument, the property might be worth 1.5 million, when we are 60 we will want to down size. We then buy a property for 1.3 million and lose out 200k mortgage. In this way we are saving 25-30% off the repayment monthly charges.

I have recently sold a 3 bed terraced. I bought it for 90k and sold it for 125k. I had interest only and made equity of 35k in 3 years. So I suppose I have been doing it already and it has been working but I a little hesitant doing it with my partner and we do have family plans for the near future.

Any thoughts?

homer_j_3

its a simplistic view on the situation to be fair.

You need to consider what happens if house prices go down and you need to sell at that point due to a chang of circumstances. Your house could be worth less than the mortgage and you wont be able to downsize.

I would also look at it that you will have repaid far more back to the bank on an interest only mortgage than you would have on a repayment so why should I give up my 200k to them at the end of it.

If a repayment mortgage is affordable, I would go down that route rather than interest only. It also depends on your attitude too.

House prices are not increasing at the rate they have over the last few years - it has become a buyers market again due to the increase in interets rates, we just need to wait for the sellers to accept that when their house have not moved for 6-12 months.

kingkano

You also need to consider what if you dont want to sell in 25years? You will need to KEEP paying the interest payment on that outstanding money.... forever in theory. Until you DO sell.

If you can afford repayment its a better idea. Or atleast make other arrangements besides 'selling my home' to pay back the capital some time in the future.

beingjdc

But you will have paid twice as much interest, because the debt won't have reduced over time...

ixwood

IR works best if you invest heavily (more than the difference in IO and repayment) early and try and pay it off early. Or at least have the funds to pay it off early.

In theory you could pay a LOT less on a IO, as opposed to a repayment. Obviously depends on your investments though. Previous history would suggest an IO mortage and investments in Stocks and shares is probably the cheapest way to pay off a house.

eira

I couldn't afford full repayment of my mortgage so had to go for interest only-mightmare is that the mortgage finishes when I'm 72 and I have no way of paying off the full sum. There is however equity in the property-not enough to buy a place in the Uk but enough to buy a place abroad. A life saver for me has been an offset Tracker mortgage.It runs at 0.495 above base rate for the life span of the mortgage. Extra payments go into the savings pot which brings down the interest as much as if it had come off the capital. This means the money is there if I need it

beingjdc

ixwood wrote: »

In theory you could pay a LOT less on a IO, as opposed to a repayment. Obviously depends on your investments though. Previous history would suggest an IO mortage and investments in Stocks and shares is probably the cheapest way to pay off a house.

Although, that's also called 'an endowment mortgage', and look how many people are sueing the banks now because they were advised to take them out (which looked like good advice at the time).

ixwood

Endowments were rubbish investments. Partly cos of poor stock market performance at the time and mostly because of very optimistic returns forecasts. And they had crappy life insurance built in.

Doesn't mean the stategy is a poor one, just the repayment vehicle was in that case.

dunstonh

ixwood wrote: »

Endowments were rubbish investments. Partly cos of poor stock market performance at the time and mostly because of very optimistic returns forecasts. And they had crappy life insurance built in.

Doesn't mean the stategy is a poor one, just the repayment vehicle was in that case.

Endowments were good the time. For a few decades people did very well out of them. However, they didnt evolve with the times. Had they evolved with widespread use of PEPs/ISAs replacing them, then we could easily be sitting here today seeing that option as a mainstream option instead of a minority option it currently is.

jamesd

Interest only is a good choice. It gives you the flexibility of overpaying up the repayment level, dropping back to interest only level or investing the difference between interest only and repayment. All as a standard feature instead of having to beg the lender later.

If you invest the difference between interest only and repayment via funds in stocks and shares ISAs you're likely to end up wth a surplus of 25% even if your investments have only mediocre performance. If they do fairly well you could end up with twice the mortgage value.

For example, 250,000 borrowed at 5.49%, interest only is 1143.75, repayment is 1533.73, difference is 389.98. The difference doesn't change if the interest rate changes, so that doesn't matter here. Invest the 389.98 a month. Get 7% investment return before inflation, after fees and you end up with 317,700, 27% more than the mortgage value. Get 9% and you end up with 440,500, 76% more than the mortgage value. Get 12%, 3% below what the best of the UK equity income funds have averaged long term, and you end up with 740,000, close to three times the mortgage value.

Inflation at 3% would mean that money is worth half of what it is today in 25 years so the 500,000 extra is worth about 250,00 in today's terms - enough to provide an annual income of 12,500 at 5% of the fund value a year. That's a good start on being able to retire in comfort.

Better still, add an extra 100 a month as regular overpayment and the results increase to 930,000 at 12% - enough to provide 17,000 in income in today's money at 5% of the fund value a year. At 7% it's 400,000 - more than enough to be sure you can pay off the mortgage.

You may not get 12% but 7% will do the job... and there is a realistic chance of getting that 12%.

homer_j_3

jamesd wrote: »

Interest only is a good choice. It gives you the flexibility of overpaying up the repayment level, dropping back to interest only level or investing the difference between interest only and repayment. All as a standard feature instead of having to beg the lender later.

Only if the product has a sufficient overpayment feature built into the product. If it does not then you cannot do this.

If you invest the difference between interest only and repayment via funds in stocks and shares ISAs you're likely to end up wth a surplus of 25% even if your investments have only mediocre performance. If they do fairly well you could end up with twice the mortgage value.

For example, 250,000 borrowed at 5.49%, interest only is 1143.75, repayment is 1533.73, difference is 389.98. The difference doesn't change if the interest rate changes, so that doesn't matter here. Invest the 389.98 a month. Get 7% investment return before inflation, after fees and you end up with 317,700, 27% more than the mortgage value. Get 9% and you end up with 440,500, 76% more than the mortgage value. Get 12%, 3% below what the best of the UK equity income funds have averaged long term, and you end up with 740,000, close to three times the mortgage value.

Inflation at 3% would mean that money is worth half of what it is today in 25 years so the 500,000 extra is worth about 250,00 in today's terms - enough to provide an annual income of 12,500 at 5% of the fund value a year. That's a good start on being able to retire in comfort.

Better still, add an extra 100 a month as regular overpayment and the results increase to 930,000 at 12% - enough to provide 17,000 in income in today's money at 5% of the fund value a year. At 7% it's 400,000 - more than enough to be sure you can pay off the mortgage.

You may not get 12% but 7% will do the job... and there is a realistic chance of getting that 12%.

What if stock markets crash? You cannot gurantee any surplus and there is an equal risk to there being a 25% shortfall. This will result on extendending the mortgage term and either waiting for investments to realise the correct value or having to transfer onto repayment.