Jump to content
House Price Crash Forum
Sign in to follow this  
Renting

Mortgages, Interest Only Or Repayment

Recommended Posts

Interest Only or Repayment?

I thought I’d continue the mortgage theme started by Dolphin. A lot of this will be old hat to most of our readers, but it may be of interest to some.

At the moment anyone thinking of buying a house may still find that they need a large mortgage. So they want to get one that keeps their monthly payments as low as possible. There are several ways of doing this, but some are riskier than others.

With all the mortgage products on the market there are actually only two types of mortgage. The repayment mortgage and the interest only mortgage. All the trackers / fixed / flexible are just ways of structuring the payments.

Let’s start with the repayment mortgage.

With the repayment mortgage the borrower will pay the interest accrued each month and a small part of the capital borrowed. That means that as long as you keep up the payments and pay on time you are guaranteed to repay the loan amount in the agreed time. The standard length of a repayment mortgage is 25 years. But by increasing the term to say 30 or even 35 years the monthly payments will come down. Going out to 40 years however will bring little further benefit. But by extending the term of the loan you will pay more in interest overall. If you overpay a repayment mortgage you will bring forward the date that you fully repay the loan. A very rough guide being that by overpaying by 5% per month you could knock 5 years off of a 25 year mortgage and turn it into a 20 year term. Generally a repayment mortgage is considered right for cautious people.

Now for the interest only mortgage.

Here you only pay off the accrued interest every month. The amount of capital outstanding remains the same. So, if you borrow £100,000 and make your monthly payments on time you will still owe the bank £100,000 when the mortgage ends! Sounds a mad thing to do, but many start out this way when buying their first house promising themselves that they will convert to repayment as soon as they can afford it. Many times they just keep extending the term as ‘that right time’ never seems to arrive. Others think that inflation will erode the loan to an insignificant amount.

Up until recently many lenders allowed people to take interest only with no strings attached. This is called ‘Pure Interest Only‘, usually associated with BTL. Now though the majority of lenders insist on there being a stated ‘repayment vehicle’ in place to pay off the loan at the end.

Repayment vehicles can take the following sort of forms:

Sale of residence - if the LTV of the loan is low and the house large then it is reasonable to say that when you get older you will downsize and pay off the mortgage in the process. Not considered reasonable for high LTV cases.

Sale of second residence - obviously fine as long as the figures stack up.

Endowment - Traditionally the vehicle of choice in years gone by. The idea being that the combined cost of the interest only payments and the endowment premiums are less than an equivalent repayment deal, and you get life insurance thrown in. The trouble is many have not performed. Mis-selling occurred if the provider promised it would meet or exceed the amount needed, when no guarantees can be given. Why mis-sell? Because you get the mortgage procuration fee as well as commission for the endowment sale, happy times for mortgage sellers.

ISA - This is run along the same lines as the endowment option with the same sorts of risks. But may not have life cover attached. There is also the temptation to spend the money as it is not tied up in the same way as an endowment.

Pension - With a pension you have the option of drawing down 25% of the value of your pension in a lump sum after the age of 50 (55 from next year!) So, as long as your pot is predicted to reach four times the size of your mortgage at the right time then you can declare this as the vehicle. Once again, a bit risky as your pot might not grow at the expected pace.

The interest only mortgage is therefore suitable for those who don’t mind taking a bit of a risk, it is considered the ‘adventurous’ option.

By overpaying this type of loan you will reduce the capital outstanding at the end.

So, interest only in one guise or another can keep your monthly payments down, but it comes with the attached risk that you may not be able to pay the loan off at the end.

One thing you can do is combine the two and have part of the loan on interest only and part on repayment. A sort of mix and match to suit your requirements. You may have an underperforming endowment you're keeping for example.

Most lenders will let you transfer from interest only to repayment, or you can just overpay to achieve it (check for Early repayment Charges with your lender first!). Lenders are very wary of letting you transfer the other way though. They think you are in financial trouble, some won’t even consider it for any reason.

At the end of the day the choice is yours, but I wonder if there are not a lot of people out there who wished they had opted for the safer option of a repayment mortgage all those years ago?

Share this post


Link to post
Share on other sites

Like so many commentators, you miss out the effect of our tax regime on the choice.

I started a SIPP last year, and it'll be my vehicle to pay off a mortgage. It currently stands at a profit of over 92% against my contributions to date, but the majority of that profit comes straight from the tax breaks.

Bottom line: I get to pay off the mortgage from income taxed at 15% instead of 55%.

Share this post


Link to post
Share on other sites

If you are taking out an IO mortgage, you probably do so as you cannot afford a repayment one. It is therefore probably fairly big. Ave mortgage in UK is aroend £104K. Let us guess an ave IO at £200K (my figures could be very wrong, but run with it...). Say a £200K mortgage on a property originally valued at £250K.

How much would that property cost to rent?

£850 pcm? = £10,200 pa. Take a long term average of Uk mortgage rates....(8% over the last 25 years...again an estimate) and you have an annual cost of £16,000 in interest on your £200k mortgage.

Why not rent the property, save some cash, let the LL pay when anything goes wrong. Works for me.

Share this post


Link to post
Share on other sites
Like so many commentators, you miss out the effect of our tax regime on the choice.

I started a SIPP last year, and it'll be my vehicle to pay off a mortgage. It currently stands at a profit of over 92% against my contributions to date, but the majority of that profit comes straight from the tax breaks.

Bottom line: I get to pay off the mortgage from income taxed at 15% instead of 55%.

Good plan, although I suspect the higher rate tax relief is going to go bye bye at some point to pay off Gordons

borrowing, so needs factoring in.

still worth doing I suspect

& I might look into it myself for a bit of my mortgage

Share this post


Link to post
Share on other sites

Can you please explain how you can pay off a mortgage via a SIPP?

I would be interested to know how this is done as I am thinking of going down this route. I thought residential property had been excluded from SIPP's schemes.

Thanks.

Share this post


Link to post
Share on other sites
Like so many commentators, you miss out the effect of our tax regime on the choice.

I started a SIPP last year, and it'll be my vehicle to pay off a mortgage. It currently stands at a profit of over 92% against my contributions to date, but the majority of that profit comes straight from the tax breaks.

Bottom line: I get to pay off the mortgage from income taxed at 15% instead of 55%.

I like this plan.

Could you explain in a little more detail how you have gone about it? IO mortgage initially, then remortgage once you have enough to pay off the principle? Also, what are the withdrawal rules of a (your) SIPP in order to pay it off?

Share this post


Link to post
Share on other sites
If you are taking out an IO mortgage, you probably do so as you cannot afford a repayment one. It is therefore probably fairly big. Ave mortgage in UK is aroend £104K. Let us guess an ave IO at £200K (my figures could be very wrong, but run with it...). Say a £200K mortgage on a property originally valued at £250K.

How much would that property cost to rent?

£850 pcm? = £10,200 pa. Take a long term average of Uk mortgage rates....(8% over the last 25 years...again an estimate) and you have an annual cost of £16,000 in interest on your £200k mortgage.

Why not rent the property, save some cash, let the LL pay when anything goes wrong. Works for me.

I think you'll find the average new mortgage is £139,000 IIRC from the BoE June figures.

Share this post


Link to post
Share on other sites
Wrong. Read my post. Do it to save tax.

most people have no idea what a SIPP is.

they go to a mortgage adviser and ask for a mortgage.

How can we afford this house we want to buy they ask.

well, the cheapest way is to pay interest only.

And other reports show people have NOTHING in place to repay the debt.

If you have enough to save in a SIPP, you have enough to do a repayment mortgage.

A repayment mortgage you can EXTEND of you cant meet repayment. An IO you cant.

you can make overpayments on a repayment mortgage too.

MOST people DONT pay 40% tax.

Share this post


Link to post
Share on other sites
Like so many commentators, you miss out the effect of our tax regime on the choice.

I started a SIPP last year, and it'll be my vehicle to pay off a mortgage. It currently stands at a profit of over 92% against my contributions to date, but the majority of that profit comes straight from the tax breaks.

Bottom line: I get to pay off the mortgage from income taxed at 15% instead of 55%.

Why not overpay the mortgage and get taxed at 0%?

Share this post


Link to post
Share on other sites

I don't think any lenders are offering IO mortgages at the moment and if they are you have to have proof of investment to pay the capital

Edited by Neil B

Share this post


Link to post
Share on other sites

The best type of mortgage for me, is no mortgage. I`d recommend it to anyone.

If you do have to get a mortgage, get a small one.

Share this post


Link to post
Share on other sites
The best type of mortgage for me, is no mortgage. I`d recommend it to anyone.

If you do have to get a mortgage, get a small one.

I would agree, get a small one, pay it down, move, get a small one, pay it down.....

...or live on borrowed money and borrowed time. ;)

Share this post


Link to post
Share on other sites

I agree, we did 100% repayment, overpayments started at 250 but after 3 years we upped it to 500 with the odd larger payment extra.

4.5 years weve gone from 130.5k to 85k. Didnt have much money afterwards though ^^ in fact we were pretty buggered for cash lol. Years of the Jone's friends telling us spend a little on yourselves, look what we bought, oh you must try x celebs new restaurant. Well i rather like where we are, i dance and get pissed with the wife and shes never been happier so um i win :D.

So my Jones friends bought 6 months after we did 138k (50% interest only) + 7.5k unsecured loan oh yes NR ;). Borrowed a further 15k+ for the wedding, i got married 4 years before on 2k, yes it was a bit hillbilly but everyone helped it had a great atmosphere. Then they needed another mortgage deal borrowed another 10k (interest only now though). I was screaming at him so if ltv drops another 10% your going to borrow another 10k your fkin crazy. Well that didnt go down to well. These peoples jobs are money and number related.

So our mortgage capital drops 85k, my mates goes up to 173k including all debts yet the still live in the same place, and they are thinking of moving ... They also have debts even before buying as well OO.

Share this post


Link to post
Share on other sites
I think you'll find the average new mortgage is £139,000 IIRC from the BoE June figures.

Cheers BL. It was £104,000 about a year ago. WHy the jump? I thought the UK was paying off personal debt. Do the CML or BOE publish figures for the average size of IO versus repayment mortgages?

Share this post


Link to post
Share on other sites
The best type of mortgage for me, is no mortgage. I`d recommend it to anyone.

If you do have to get a mortgage, get a small one.

Yes this is the best advice.

Having no mortgage or rent to pay is the goal, so why do some people push it further away?

Share this post


Link to post
Share on other sites
I agree, we did 100% repayment, overpayments started at 250 but after 3 years we upped it to 500 with the odd larger payment extra.

4.5 years weve gone from 130.5k to 85k. Didnt have much money afterwards though ^^ in fact we were pretty buggered for cash lol. Years of the Jone's friends telling us spend a little on yourselves, look what we bought, oh you must try x celebs new restaurant. Well i rather like where we are, i dance and get pissed with the wife and shes never been happier so um i win :D.

So my Jones friends bought 6 months after we did 138k (50% interest only) + 7.5k unsecured loan oh yes NR ;). Borrowed a further 15k+ for the wedding, i got married 4 years before on 2k, yes it was a bit hillbilly but everyone helped it had a great atmosphere. Then they needed another mortgage deal borrowed another 10k (interest only now though). I was screaming at him so if ltv drops another 10% your going to borrow another 10k your fkin crazy. Well that didnt go down to well. These peoples jobs are money and number related.

So our mortgage capital drops 85k, my mates goes up to 173k including all debts yet the still live in the same place, and they are thinking of moving ... They also have debts even before buying as well OO.

Some people out there have got so used to cheap money that they have lost any instinctive "debt aversity". Fine in a low IR environment. Rabbits in the headlights if rates go up!

Share this post


Link to post
Share on other sites
Cheers BL. It was £104,000 about a year ago. WHy the jump? I thought the UK was paying off personal debt. Do the CML or BOE publish figures for the average size of IO versus repayment mortgages?

Well, I think its something to do with the lack of low wage earners entering the market, only those who had high resources could play...Hamish used to bang on about this as being the way the market was going to go.

short term, it seems he had a point.

Share this post


Link to post
Share on other sites
Guest happy?
Why not overpay the mortgage and get taxed at 0%?

The money you are overpaying the mortgage with would already have had income tax deducted (and this will vary depending on your income level). Porca has opted to pay this money directly into their pension pot which means it is exempt of income tax - particularly beneficial if you're a higher rate tax payer.

Porca's plan will be to draw down this money on retirement (max 25% of total pension pot) and use it to repay the interest-only mortgage. Porca has to calculate whether having an interest-only mortgage for their whole working life is cheaper than holding a repayment mortgage for say 25 years.

The other benefit Porca will gain is that at retirement Porca is likely to be a basic-rate taxpayer and then any interest on other investments will also be taxed at a lower rate.

For most people the greatest gain they can make with any investment is to reduce taxation to zero - a basic rate taxpayer increases the performance by 20% and a higher-rate taxpayer by 40% - this is why I am puzzled by newspaper pundits advising people not to use up a full ISA allowance because they can currently get a better deal on non-ISA products - a more short-term approach to tax I can't imagine.

Share this post


Link to post
Share on other sites
The money you are overpaying the mortgage with would already have had income tax deducted (and this will vary depending on your income level). Porca has opted to pay this money directly into their pension pot which means it is exempt of income tax - particularly beneficial if you're a higher rate tax payer.

Porca's plan will be to draw down this money on retirement (max 25% of total pension pot) and use it to repay the interest-only mortgage. Porca has to calculate whether having an interest-only mortgage for their whole working life is cheaper than holding a repayment mortgage for say 25 years.

The other benefit Porca will gain is that at retirement Porca is likely to be a basic-rate taxpayer and then any interest on other investments will also be taxed at a lower rate.

For most people the greatest gain they can make with any investment is to reduce taxation to zero - a basic rate taxpayer increases the performance by 20% and a higher-rate taxpayer by 40% - this is why I am puzzled by newspaper pundits advising people not to use up a full ISA allowance because they can currently get a better deal on non-ISA products - a more short-term approach to tax I can't imagine.

Thanks for the explaination. Definately requires a lot of thought before going down the same route as Porca.

WRT the ISA statement, you are referring to tax on savings right? and therefore a longer term approach to saving in an ISA (not touching it until later in life).

Share this post


Link to post
Share on other sites
Can you please explain how you can pay off a mortgage via a SIPP?

I would be interested to know how this is done as I am thinking of going down this route. I thought residential property had been excluded from SIPP's schemes.

Thanks.

The SIPP is a tax-efficient way to save.

When you retire, you get to take out 25% as a tax-free lump sum. That goes to pay off the mortgage.

So you can a mortgage of £250k for the price of a £150k repayment mortgage - as the latter is taken from taxed income.

But it's not for everyone. If you're a long way from retirement (say, under 40) it would look a whole lot less attractive. And if you earn under ~£44k or over ~£150k, the tax case becomes marginal at best.

Share this post


Link to post
Share on other sites
Good plan, although I suspect the higher rate tax relief is going to go bye bye at some point to pay off Gordons

borrowing, so needs factoring in.

still worth doing I suspect

& I might look into it myself for a bit of my mortgage

If the tax relief goes, then the whole plan changes. Simple.

But bear in mind that next budget will coincide with a change of government, which should put a lid on certain forms of silliness. And starving UK PLC (the productive economy) of all the pension money that'll flow out if they kill off my tax benefits would be pretty suicidal[1].

[1] The £150k thing is basically irrelevant, because

  1. The lifetime limit means pension investment is already not tax-efficient for very high earners

  2. The very rich tend to have other vehicles for tax saving.

Share this post


Link to post
Share on other sites
If the tax relief goes, then the whole plan changes. Simple.

But bear in mind that next budget will coincide with a change of government, which should put a lid on certain forms of silliness. And starving UK PLC (the productive economy) of all the pension money that'll flow out if they kill off my tax benefits would be pretty suicidal[1].

[1] The £150k thing is basically irrelevant, because

  1. The lifetime limit means pension investment is already not tax-efficient for very high earners

  2. The very rich tend to have other vehicles for tax saving.

Porca, who is your SIPP provider?

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
Sign in to follow this  

  • Recently Browsing   0 members

    No registered users viewing this page.

  • The Prime Minister stated that there were three Brexit options available to the UK:   285 members have voted

    1. 1. Which of the Prime Minister's options would you choose?


      • Leave with the negotiated deal
      • Remain
      • Leave with no deal

    Please sign in or register to vote in this poll. View topic


×

Important Information

We have placed cookies on your device to help make this website better. You can adjust your cookie settings, otherwise we'll assume you're okay to continue.