Redemption Penalty workaround

MarkyMarkD

You won't get a mortgage with a total cost (including remortgage fees) of SVR-2.34% IMHO. That's simply too cheap for the lenders to do it.

What you are proposing doesn't make sense either. You would be "saving" £8,244 in repayments, but your capital outstanding would be £9,101 higher at the end of the 3 years. You'd actually be £857 worse off. That would be OK if you could earn more than £857 in interest on the difference in payments, but you wouldn't do so.

You've got the money available to make repayments, rather than interest only payments, so what benefit are you achieving by not doing so?

gil13

SVR 7.3%
FD 10 year offset 5.49 % = 1.81 % better.
FD 5 year offest 5.29 % = 2.01 % better.
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I know I would be £857 worse off over the 3 years in theory..
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"Saving" I/O vs Repayment, £2748 per year (6% return/achievable I think via ISA or if my wife is non tax payer at some point), £164.88 first year alone. But this is not really relevant, because we have the £9101 in the bank, at 6% = £546 interest year 1 alone, compounded over the 3 years in fact comes out at £1738..this is looking even better..
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very simply if I paid off £9101 from 135K at SVR 7.3%/21 years = £980 pm
interest only on same amount (125,899) is £765 pm (admit this is a different calculator but gives rough figure)
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I hold my hands up and having been going over and over these figures my brain is now dead and I could well be going totally down the wrong road - but it seems to make sense to me:rolleyes:

MarkyMarkD

By paying interest only, rather than repayment, you don't have £9,101 of spare cash right away. You don't earn £546 per interest each year.

All you have - incrementally - in the first month is the amount of difference in payments in the first month, i.e. £229. On that, you'll earn about £12 per year in interest.

In the second month, you'll have 2 x £229. So you'll earn around £24 per year - but only for 11 months, so more like £22.

And so on.

As you say, in the first year you'll save £2,748. So the average is £1,374. On which you'll earn £82. In the second year, you'll average £4,122 on which you'll earn £247. In the third year, you'll average £6,870 on which you'll earn £412.

In total, you'll earn £741 on the difference in payments.

And you'll be £857 worse off (as I showed before).

So net, you'll be down over £100.

jamesd

gil13, as MarkyMarkD says it'll be tough to find a deal sufficiently below SVR but some lenders are increasing their SVRs to increase their profitability and there might be an opportunity if yours does that and another doesn't.

Instead of paying interest only, consider the following approach:

1. Pay off 10% from savings.
2. Pay off interest only from the regular income and the capital repayment part from savings. Or subsidise the monthly interest payment from savings as well, to keep the loss of current income as low as required.
3. Pay off 10% next time you can, subject to keeping enough in savings and investments to meet whatever safety margin you want (at least 6 months of total expenses including mortgage is the lowest I suggest going).
4. Continue subsidising the monthly repayments from savings, allowing for this in your calculation of how much to pay off in 3, reducing that by as much as is necessary for the subsidy level you want.

This plan gets you reduced interest payments for as long as possible by reducing the capital as early as possible with initial lump sum payment but the subsidy from savings keeps your loss of monthly income down.

If you don't get a better mortgage deal, look to see if a personal loan can be had for lower than SVR and if it can be, consider using that to repay more capital, using say a five year term to keep the monthly cost down (and paying the repayments from the loan itself). Then repay the loan when you remortgage - it's just to save you the interest rate diffrence between SVR and whatever loan rate you can get.

MarkyMarkD

Thanks for the clear explanation, jamesd.

But I'm not sure that I follow the need to borrow to repay - the OP already has lots of savings. Granted that, if the savings are exhausted, it might be worth borrowing more cheaply to repay the mortgage, but the extra payments on a short-term personal loan will make the aggregate outgoings (mortgage + personal loan) way too high at the point where the savings have gone.

Borrowing on a personal loan and repaying that loan with the loan itself is mad!

jamesd

You're 100% certain that you have access to your savings if you keep them. You're not 100% certain of being able to get a loan while unemployed or sick - more the opposite. So you take the loan so that you preserve your emergency fund.

You repay the loan using some of the loan capital so that the loan doesn't increase the net monthly outgoings.

gil13 has savings and investments to pay off 10% for one year and maybe two while using savings to subsidise the monthly payments. After allowing for the emergency fund that leaves no money available to pay 10% for the third year. That's where the personal loan may be of interest. It's not worth bothering with unless there's a fair difference between SVR and personal loan rates.

Say the loan is available at 6.5% while SVR is 7%. The loan saves 67.50 in mortgage interest less loan interest for the year, 0.5% of 13,500. If repaying over 7 years (in theory, repay when remortgaging) the monthly repayments are 199.25 - 5.62 in reduced mortgage payments. To pay them you need to borrow 2324 more and at 6.5% that costs you 151.06 in interest. Until you use it you put the loan monthly payment money in a savings account. 2324 for a year's repayments loan if you can get 4% interest after tax, a rough approximation of 2% will be earned on the declining savings balance during the year, about 46.

For that 0.5% loan rate difference the gain/loss is 67.50 - 151.06 + 46 = -37.56, a loss, so no point in doing it if you're going to borrow to make the repayments.

If the loan rate difference was 0.75% (7% vs 6.25%) the mortgage interest saved is 101.25, 8.43 a month. Loan repayment cost is 197.72 a month less 8.43 in reduced mortgage payments, net 189.29 a month. Borrowing twelve months of that, 2271.48 costs 141.97. Interest on the savings is 45.42. Gain/loss is 101.25 - 141.97 + 45.42 = 4.70 gain.

To make any really useful difference the rate difference would need to be at least 1%, or if interest rates are rising and the loan is at a fixed rate it may pay if it's less to start. Also more likely to pay if the loan repayment money is in a tax free account instead of taxed.

But the potential gain is pretty marginal if borrowing to make the repayments.

If there's no need to borrow the repayment money for the loan but instead it's costing just 4% lost interest on money in a taxable savings account, that changes the picture considerably and makes it profitable even with 0.5% rate difference: mortgage interest saved is 67.50, savings interest lost on the repayments is about 46.48 so the gain for the year is about 21.

Even so, that's not a lot of money for the work involved and I doubt it's worth the hassle until the rate difference is at least 0.75%.

But this is where family and friends can help. If gil13 is paying 7%, gil13 could offer family and friends 6% tax free to borrow money for a year. That's 1% clear profit for gil13 and the family and friends could be better off as well. 50-50 split between best after tax (or tax fee if available) savings rate for the family member and mortgage rate is how I'd do it. If there's a higher rate tax payer in the family that could work out rather well.

MarkyMarkD

Right. So that boils down to "yes, it was a silly suggestion" does it, jamesd?

Personal loan rates are not as low as they once were. I think your assessment of the rate differential required is about right; I think you'll be pushed to get that level of rate differential and I think that the saving (if any) is so minimal that it's not worth the hassle.

Borrowing from family and paying them "tax free" interest is illegal. They should declare the interest they are earning. Just because it's from an individual, not a financial institution, doesn't make it tax free.

jamesd

Whether it's silly would depend on what the differences in interest rates available are and whether the return looks worth the hassle to gil13. A hundred pounds or so was enough for me to open a bank account... so I gave a range of cases to give an idea of the requirements for it to be worthwhile.

I assume that you're correct about the tax treatment of interest, I haven't checked but it would make sense. gil13 should certainly not encourage a family member not to declare their tax liability. I suppose a tax expert could say if there was a way to structure an arrangement to eliminate the tax concerns.

So, find a family member who thinks that Premium Bonds are a great deal and offer them the before tax equivalent of PB rates.

Or start betting on whether their favorite team will win or lose its next match, they take the money if it's a draw, assuming that the usual gambling gains being tax free applies when one side has an idea of the loss that they are willing to sustain before stopping.

gil13

Hello again, some interesting thoughts but I wont be taking out a loan or starting a betting syndicate with the family :-) I am just interested in the numbers as follows:

135k.
If I go I/O for the 3 years I will "save" £8244.
Repayment mortgage over the 3 years would amount to £9101.
so over the 3 years I would be £857 worse off.

If I overpaid 10% (13.5k) the monthly payment would be app £953
If I went Interest only for 3 years the monthly payment would be £821

If I held that 13.5K and earnt interest on it at 6% over the 3 years would give a return of £2578 less the £857 deficit I had at the end of the 3 years by going I/O, would leave £1727.

I am assuming that I missing the point with regards to the effect of the interest on monthly payments and when capital reduction is made, at least that's all I can think of.

With regards to the future of rates, the BS have been reducing in line with BOE I see no reason for this to change. Some of the money market funds and fix rates have been moving up but who knows where this will end up, swap rates have been indicating very marginal reductions but this might all change next week. I suspect the BOE will be forced to cut now that that the FED are in cut mood and I just get the feeling that end of the year that some of the fixes will start to drop a 1/4 or two.

MarkyMarkD

I'm too tired to explain the numbers again.

Just accept that your strategy is not going to save you money.

The only way to save money is to have a lower mortgage balance, which means repaying capital.