Interest only - what's the best way?

vwjo

IF we were to go for an interest-only mortgage, and pay the £200 difference (as opposed to repayment) per month into a savings account, what's the best way to use those savings? Would you want to continue saving until the end of the mortgage term and then pay off the lump sum all in one go, or would it be better to each year pay off the mortgage with what you have saved?

Sorry if this a stupid question, thanks in advance for any and all help....

magyar

In theory you are probably going to be better off paying the money off your mortgage as you go. If you are paying, say, 5% interest on your mortgage then you need to earn more than 5% after tax for you to be better off saving the money until the end of the mortgage term.

I like interest-only mortgages because they give a lot of freedom. You can save the money as you describe and probably earn slightly less interest than you're paying on the mortgage, but with the flexibility of being able to pay more off if you need to.

However it's hard to give a definitive right/wrong without seeing the specific circumstances.

Gorgeous_George

At the moment, ISAs pay more than my mortgage rate so I save using ISAs.

A couple with a £150,000 mortgage over 25 years at 6% would pay £966.45 per month on a repayment mortgage or £750 per month on interest only.

Save £216.45 (the difference beteen IO and repayment) in ISAs at 6.5% and they will reach £150,000 in savings after 24 years - saving them a year of mortgage payments at £966.45.

GG

vwjo

Thanks Magyar.... the property we would like is 140k, and we have 7k deposit - the majority of repayment mortgage deals we have seen will have us paying around £850 per month - which is ok - but it seems that going for an interest-only mortgage is knocking more that £200 per month off....which we would put aside (and a little more, hopefully!) If we chip away at the £133k mortgage amount each year, does that mean that our mortgage payments would also decrease, since that £133k original amount would be less, so the interest would be less?

Basically, on an interest only mortgage, paying off say,3k per year, would our payments each year be decreasing? Because if they did, then we would be able to pay even more each subsequent year to the original loan amount...?

(Based on a fixed rate of interest, that is...) And ISA would be my preferred place for savings....?

I hope my question makes sense........ :-)

vwjo

Thanks George, thats what I figured...... so long as you can get a decent interest rate, it would seem that interest only mortgage is not such bad idea (so long as you know where you are up to along the way!)

It's just that question of whether its better to chip away at the original loan amount, or save the whole lot to pay in one go at the end.....

dimbo61

Hi vwjo if you can get an interest only mortgage the lender wants to know that you have a saving vehicle to pay off the mortgage at the end of the term.
ISA,s are indeed paying 6.5% barclays and (lloydstsb if you pay in £9000+)
BUT that will not always be the case as rates were only 3.5% not that long ago. alot of ISA,s have a bonus for the first year of say 0.5/1% so you need to look for the best deal each year.
Having a repayment mortgage will mean that the mortgage will be paid off at the end of the term no matter what the interest rate as your lender will increase or decrease your payment to clear the debt.
ISA,s are at the moment offering good rates and are a good place to build up an emergency fund which could then be used to pay lump sums off your mortgage when required BUT this takes good money management.
GOOD LUCK

magyar

vwjo wrote: »

Thanks Magyar.... the property we would like is 140k, and we have 7k deposit - the majority of repayment mortgage deals we have seen will have us paying around £850 per month - which is ok - but it seems that going for an interest-only mortgage is knocking more that £200 per month off....which we would put aside (and a little more, hopefully!) If we chip away at the £133k mortgage amount each year, does that mean that our mortgage payments would also decrease, since that £133k original amount would be less, so the interest would be less?

It makes perfect sense :beer:

If you're on an interest-only mortgage then yes your repayments will simply drop if you pay off a lump sum.

What you can do is put your money into an ISA which - as the others have said - are currently paying more interest than you're paying on a mortgage, and then review this year on year.

If the ISA rate remains higher than the mortgage rate, then keep your money in there.

If ISA rates drop and you end up paying more in mortgage interest than you are earning then pay a lump sum off.

Questions to consider and ask your ISA/mortgage providers
- what is the maximum lump sum you can pay off (usually around 10% a year)
- when will the lump sum be deducted from your mortgage premium (usually this is immediate, but some providers just put this money into an account earning no interest :eek: and only remove off the mortgage balance once a year)
- make sure you consider all costs e.g. ISA withdrawal and annual service costs etc.

vwjo

Perfect answer Magyar! Lets have another one! :beer:

That makes perfect sense now. If savings interest is higher that mortgage interest, keep saving. If the other way round, then chip away at the mortgage. Perfect.

The only possible drawback to this idea (rather than repayment) seems to be that you have to keep a close eye on your money. But I don't think that's an issue for us, we're fairly on the ball...:o

Will the mortgage chaps want to see actual evidence of the savings account being already set up?

magyar

vwjo wrote: »

Will the mortgage chaps want to see actual evidence of the savings account being already set up?

Yes, and also will probably ensure you have sufficient earnings to cover typical payments - which of course you should do yourself anyway.

But in practice once you've got the mortgage set up you can switch or close accounts and they won't 'chase you'.

dwsjarcmcd

vwjo wrote: »

Will the mortgage chaps want to see actual evidence of the savings account being already set up?

Actually they probably won't, simply because anyone can open an account, stick a tenner in and use it as evidence of an account then never put in any more or close it.

One thing to consider may be an Offset mortgage, which will always at least match your mortgage rate, is more flexible in terms of overpaying and is not hampered by funding limits. You also have the choice to use overpayments to reduce your monthly outgoing or reduce your mortgage amount.

vwjo

Hmmm. Offset mortgage. Just when it all becomes so clear, another option muddies the water! :-)