Interest only mortgage - In a year how much do I pay off the "true interest?"

bar_1

Hi,

I am considering getting an interest only mortgage for a fix rate of 2 years. I am trying to find out how much I would pay off the true interest and how much is paid off the additional interest you are being charged for having an interest only mortgage.

Does this make sense?

Thanks,

Bar

bar_1

No, I mean, if when borrowing 115,000 interest only we pay around £200,000 interest over 25 years, then have to pay back the £115,000 at the end. But if after 2 years we switch to repayment I know we wouldn't have paid of any of the 115,000 capital but we should have paid of some of the "true interest" sholudn't we?

So if we had got a repayment mortgage we would have paid off a percentage of the capital and a percentage of the interest after 2 years.

For example if I pay into an interest only mortgage, borrowing 115,000 at £560 a month for 2 years fixed rate = £13,440 paid in. If we switch to a repayment after this period what of this £13,440 has been paying of the mortgage interest and what has been paying off the additional interest?

Sorry I can't explain what I eamn any better.

dmg24

You're not making much sense bar 1, interest is interest, whatever type of mortgage you have.

What do you mean by 'true interest'?

bar_1

OK, I will try again.

With a mortgage of £115,000 you pay around £100,000 interest. after two year some of what you have paid in should have been towards the capital and some towards the interest yeah?

with interest only you are paying £115,000 at the end of the term and around £200,000 interest. So around double the interest compared to a repayment loan.

What I want to know is if I have paid off £13,000 in two years on an interest only mortgage and switch to a repayment mortgage of 25 years and the deal is £100,000 interest on the £115,000 capital. Have I eaten into some of the interest already from what I have previously paid? or is the interest paid over the first 2 years for the interest only mortgage (13,000) lost or does some of that come of my new 100,000 interest paid?

Does that make sense now???

Stargazer_Lily

bar_1 wrote: »

No, I mean, if when borrowing 115,000 interest only we pay around £200,000 interest over 25 years, then have to pay back the £115,000 at the end. But if after 2 years we switch to repayment I know we wouldn't have paid of any of the 115,000 capital but we should have paid of some of the "true interest" sholudn't we?

So if we had got a repayment mortgage we would have paid off a percentage of the capital and a percentage of the interest after 2 years.

For example if I pay into an interest only mortgage, borrowing 115,000 at £560 a month for 2 years fixed rate = £13,440 paid in. If we switch to a repayment after this period what of this £13,440 has been paying of the mortgage interest and what has been paying off the additional interest?

Sorry I can't explain what I eamn any better.

Do you mean how much of the amount that your debt has increased by due to interest will you have paid off? It should be all of the interest accrued regardless of whether you go I/O or repayment. The alternative, where the amount you owe increases becasue of underpayment of the interest is called "negative amortization" and is often found in the US, but rarely in the UK.

Example: If you borrow £115,000 I/O your monthly payments will be to repay the interest accrued on the £115,000 during that month. At the end of the period you will still owe £115,000 but your bank will have made a lot of money from you.

If you borrow £115,000 on a repayment mortgage then your repayments will be the interest accrued during that month on the £115,000 (typically the same as if you were I/O) PLUS plus an amount towards the repayment of what you owe. In the long term the amount you owe will decrease, but initially most of the payment will go to repay the interest, only chipping small amounts away at the actual money borrowed. At the end of the period the bank will still have made the same amount of money from you, but you will be the sole owner of your home.

Lil

dmg24

No, not really!

Do you mean:

You want to go interest only for the first 2 years, then repayment for the next 23 years. You know that you are not paying anything off the capital element for the first two years.

When you go to repayment, you will still owe £115,000. The total interest due on this amount will be calculated over 23 years (or whichever term you choose). The amount paid before this will have no relevance to this interest calculation.

Any help?! x

bar_1

Hi Lil,

Not quiet what I mean, I know we wouldn't have paid of any of the capital but want to know what happens when we swicth to a repayment in say 2 years. We would have paid of around £13,000 towards the interest only mortgage but what of that amount is going to count towards/has been invested towards our re-mortgage.

If we were switching from a repayment mortgage to another repayment mortgage of £115,000 fixed pay 2 years and had paid in £16,000, this should mean we borrow -£16,000 then previous. So how does that work when switching from interest only to repayment?

Maybe I don't "get" something, or I am just very poor at trying to explain what I mean!

Bar

bar_1

Thanks dmg24

Yes, so I would have paid off 2 years worth of interest but just at a higher rate. So if on average an interest only mortgage is paying back 200,000 interest and a repayment is paying back 100,000. Over 2 years at interest only I have paid back 16,000 interest, no capital (which would have been around 8,000 if it was a repayment mortgage). Therefore when I re-mortgage they will deduct around 8,000 interest?

dmg24

bar_1 wrote: »

Thanks dmg24

Yes, so I would have paid off 2 years worth of interest but just at a higher rate. So if on average an interest only mortgage is paying back 200,000 interest and a repayment is paying back 100,000. Over 2 years at interest only I have paid back 16,000 interest, no capital (which would have been around 8,000 if it was a repayment mortgage). Therefore when I re-mortgage they will deduct around 8,000 interest?

No, they would not deduct any interest! Sorry ...

Best thing to do, is to get a KFI for the following scenarios:

25 years paying interest only.

25 years on a repayment basis.

2 years on interest only followed by 23 years on a repayment basis.

On each of the KFI's, it will state the total amount payable.

Is this what you mean?! x

Stargazer_Lily

bar_1 wrote: »

OK, I will try again.

With a mortgage of £115,000 you pay around £100,000 interest. after two year some of what you have paid in should have been towards the capital and some towards the interest yeah?

with interest only you are paying £115,000 at the end of the term and around £200,000 interest. So around double the interest compared to a repayment loan.

What I want to know is if I have paid off £13,000 in two years on an interest only mortgage and switch to a repayment mortgage of 25 years and the deal is £100,000 interest on the £115,000 capital. Have I eaten into some of the interest already from what I have previously paid? or is the interest paid over the first 2 years for the interest only mortgage (13,000) lost or does some of that come of my new 100,000 interest paid?

Does that make sense now???

Oh, I think I get what you mean now!

You really need to look at some illustrations to see what is happening: Using some rough figures from Charcol:

1 - interest only for 25 years:

Monthly Payment - £742

Total Cost of Loan - £339,109

2 - Repayment for 25 years

Monthly payment - £806

Total Cost of Loan - £241,800

3 - IO for 2 years, Repayment for 25 years

IO monthly payment - £742 (x 24 = £17,808)

Repayment monthly payment - £806 (x 300 = £241,800)

Total Cost of Loan = £259,608

So, by going for option 3 you're paying a bit more because for two years you are not repaying the capital.

Does that help?

Lil

bar_1

Yes! Sorry, I miss read your last post. This is what I mean! Now I can work out what we would "paid off" with an interest only mortgage for the first 2 years.

Thank you very much x