I must be missing something in my repayment v interest only calc:

Flugelhorn

lazer-zxr said:

Flugelhorn said:

all mortgage companies much more wary of people having IO these days 

.... and what's the best way of satisfying their waryness?

Honestly don't know - haven't applied for a mortgage since before the 2008 crash and they just decided (themselves) that it could be paid off by my pension lump sum. Was a different world then 

Hoenir

For context here's a link to the Financial Services Authority  - Mortgage Market Review: Responsible Lending published in July 2010. This shaped the mortgage market as it exists today. 

https://www.fca.org.uk/publication/consultation/fsa-cp10-16.pdf

lfc321

lazer-zxr said:

Scenario 1:

Repayment £1388 per month, which is £16.6k per year, and over 15 years, this is £250k.

Scenario 2:

If I went interest only:

Mortgage interest payments £649 per month, which is £7.8k per year, and over 15 years this is £117k

I'd then have to purchase the house, which is £184k ..... so total cost to me is £117k + £184k = £301k

However, the spare monthly amount of £739 (being the difference between £1388 repayment mortgage and £649 interest payment), invested for 15 years at 4.5% compounding, I would have £190k in  savings.

So net cost to me in Scenario 2, is £190k, less my £301k cost, = £111k

So scenario 1 costs me £250k, and I have a house after 15 years.

Scenario 2 costs me £111k and I have a house after 15 years.

What am I missing here?

Your maths is not right on Scenario 2, because you are still paying out £1388 per month -  you're just splitting that between the mortgage payments (£649)and your ISA (£739). The total amount you've "paid out" over 15 years is the same in both scenarios (£250K).

Scenario 2:
You would pay interest of £117,000
You would then need to pay the £184,000 for the house.
Happily (under your assumptions, at least) your investment of £739 per month would have grown into a pot of £190,000. You can pay for the house and have £6,000 left over.


So you are strictly correct, but there isn't much in it: if your interest rate assumptions over 15 years are borne out, you would come out of Scenario 2 £6,000 ahead. For me, that wouldn't be sufficient benefit to cover the increased risk, but I guess that's a question for you.

amnblog

lazer-zxr said:

Flugelhorn said:

all mortgage companies much more wary of people having IO these days 

.... and what's the best way of satisfying their waryness?

Having a huge chunk of equity (perhaps £300K) and a six figure income 

lfc321

Correct maths for Scenario 2 (based on your figures):

Costs:
Interest payments: £117,000
£739 into ISA per month for 15 years: £133,020
Total: £250,020

Paying off capital (cost of house) at end of loan
Capital to be paid off: -£184,000
Amount deposited in ISA: +£133,020
Interest earned in ISA*: +£56,470
Total: +£5490 (this is what you would have 'spare' after paying off the capital).

* This is based on your assumption that your savings rate stays at 4.5% for 15 years.

Exodi

From a strictly mathematical and financial standpoint, based on historical returns, taking out an interest only mortgage for as long as possible and investing the difference in payments saved (in an S&S ISA) when compared to a repayment mortgage would yield better returns. This is simply because investment returns have been higher than mortgage rates. If you continue the logic that investment returns > mortgage rate, you will find that it is advantageous to go for the maximum term possible and remortgage at every opportunity. You are effectively leveraging your mortgage.

But humans are not infallible. Mortgage over-payments are routinely encouraged on this forum while technically being financially disadvantageous, for the simple reason that we place value on emotive elements (like the feeling of security and being mortgage free). For others, having a massive pot of cash may prove too tempting and (as can be seen from the past) has historically led to people simply not offsetting the difference, or people using the money for things like renovations, and then sueing the advisers for 'bad advice'.

Hoenir

Exodi said:

From a strictly mathematical and financial standpoint, based on historical returns, taking out an interest only mortgage for as long as possible and investing the difference in payments saved (in an S&S ISA) when compared to a repayment mortgage would yield better returns. 

The Nikkei index crash saw an end to the endowment era. Funds under management never recouped the losses. 

An old adage. 

"Financial disasters happen when the last person who can remember what went wrong last time has left the building". 

lfc321

Even if interest rates stay favourable, small-scale arbitrage between saving and borrowing rates is never going to be a big earner at the consumer banking level.
(In this case, even if saving and borrowing rates stay exactly as they are now, the OP will only see a 'profit' of <£6K in 15 years' time).

BikingBud

Exodi said:

From a strictly mathematical and financial standpoint, based on historical returns, taking out an interest only mortgage for as long as possible and investing the difference in payments saved (in an S&S ISA) when compared to a repayment mortgage would yield better returns. This is simply because investment returns have been higher than mortgage rates. If you continue the logic that investment returns > mortgage rate, you will find that it is advantageous to go for the maximum term possible and remortgage at every opportunity. You are effectively leveraging your mortgage.

But humans are not infallible. Mortgage over-payments are routinely encouraged on this forum while technically being financially disadvantageous, for the simple reason that we place value on emotive elements (like the feeling of security and being mortgage free). For others, having a massive pot of cash may prove too tempting and (as can be seen from the past) has historically led to people simply not offsetting the difference, or people using the money for things like renovations, and then sueing the advisers for 'bad advice'.

Yes humans are fallible, but more importantly the systems react to what decisions humans make, often following misinformation or undue influence.

The systems are designed by humans, sometimes by those who stand to gain most and are vey happy peddling misinformation. Hence fees form endowments were always paid yet the punters were advised there "is likely to be shortfalls". The bank always wins!

Some humans are driven purely by greed hence the ease in which con-artists perpetually manage to separate vulnerable people from their cash. Others are more influenced by the certainty that they can get into their lives, pay the debt early and decide what you want to do with the cash or perhaps even consider what they can now do rather than having to earn that cash, which would likely have to include a 20% or 40% premium to cover PAYE.

We also, as you acknowledge, see people that have no pathway to paying off the capital once the interest free agreement finishes. From that people on repayment would be deemed to be better off.

As @lfc321 commented the calculated benefits appear to be marginal and we don't know how the newly elected government plans to tinker yet!

silvercar

lazer-zxr said:

Flugelhorn said:

all mortgage companies much more wary of people having IO these days 

.... and what's the best way of satisfying their waryness?

Low LTV and high income as compared to salary multiples for the mortgage required and in absolute terms. I’ve seen 70k single income banded about. They may be other factors eg age, repayment vehicles etc You can also do part repayment and part IO.