How Do Interest Only Morgages Work?

[Ignorant Steve]

You can't pay off the priciple with IO. So if you overpay, assuming no penalties, you will just pay off the interest earlier. There is nothing to stop you investing the additional £150 elsewhere though, and if you manage to get a better return than the amount of the principle over the term, you will have beaten the repayment mortgage.

Yes you can pay off the principle with an IO mortgage - it's one of the major selling points.

Does the lender follow this up after the initial mortgage application? Do they check your investment vehicle after say 1 year, 5 years, 10 years to make sure you are doing what you promised in your mortgage application?

Why should they? That's the borrowers responsibility.

[MarkG]

Do they check your investment vehicle after say 1 year, 5 years, 10 years to make sure you are doing what you promised in your mortgage application?

That's not a problem, because only the most responsible of people would ever take out an interest-only mortgage: those who are so desperate and stretched to 'get on the ladder' that they can't even afford a repayment mortgage would never take out an interest-only lie-to-buy at eight times their income.

[Ignorant Steve]

You nutter.... why does the CML produce stats for IO morgages with no specifed repayment vehicle? 20% of people applying for morgages appear to be able to get IO morgages without telling there provider they are saving... Many/Most of these people wont have a repayment vehicle.

The people on this graph have ticked a box, and the provider trusts them....

That may have been true a while ago - try applying for an IO mortgage today.

There's no way in todays blame culture that lenders will leave themselves liable for too many unpaid mortgages.

[Sisyphus]

Why should they? That's the borrowers responsibility.

you contradict yourself:

Try applying for a IO mortgage and see how far you get without proof that you will pay off the full amount.

get your act together

[AteMoose]

well i would expect this graph to drop to 0%... its still at 18%. This is the latest CML data, so the change your suggesting has happened hasnt happened yet....

[Ignorant Steve]

That's not a problem, because only the most responsible of people would ever take out an interest-only mortgage: those who are so desperate and stretched to 'get on the ladder' that they can't even afford a repayment mortgage would never take out an interest-only lie-to-buy at eight times their income.

Complete nonsense. Who says repayment is the most efficient way of paying off a mortgage? It may be the cheapest most reliable and most easily understood and therefore recommended for financial numpties but to assume only the poor take out IO is a farce.

[OzzMosiz]

Complete nonsense. Who says repayment is the most efficient way of paying off a mortgage? It may be the cheapest most reliable and most easily understood and therefore recommended for financial numpties but to assume only the poor take out IO is a farce.

Not only the poor take out IO, but I'd say a large amount of poor, desperate to get on 'the ladder', have done so, and I have seen so many examples, that it's quite frightening.

[teddyboy]

Hmmmm - My brother in law and his wife are banking on their 'inheritance' to pay of their lie-to-buy / interest only / no endowment / reliant on 'inheritance' / leasehold / buy at the top of the market mortgage.

They have really p'd my husband and me off over the past few years. They have been trying to get us to buy for a long time - they think we're childish and foolish for renting. They don't have a proper job between them - one is a jobbing actor, the other a stay at home mum (fair enough). They made a small profit on a flat they had in london - paid of their credit card debt, then bought again last May

The reason they p'ss me off so much is the fact that they think they're some kind of investment gurus - they even offered to come round to see us to help us buy somewhere - what they meant was tell us how to lie to the bank to pretend we're on incomeX ,apply for an interest only mortgage & buy at the top.

I don't know whether they:

A Do, GENUINELY believe they are property developers who are going to make a massive profit on their hideous house and want us to have the same (i don't think so)

or

B Are more Machiavelian than that, and just want us to be in the same boat as them (safety in numbers etc - Crash Gordon won't let house prices go down - it would affect too many people, kind of mentality)?

Anyway - my husband has been compliling his superb "HOUSE PRICE CRASH COMPENDIUM PARTY PACK" for the past 4 years - it's going to be so pleasurable to invite the gloating b'strd's round when the crash is well and truly underway and show them that we haven't been quite as ignorant as they thought we were...

What a pleasing story

I thought an I/O Mortgage is the borrowing of the money and not the asset? IE Even if house prices HALVE! then the bank will be happy as long as the payments are met. As far as I know they cannot take the house because you do not own the house. They can at any stage they feel fit call in the loan if you default but as long as you give them back what you borrowed 25 years earlier (plus the 0000000's of pounds of interest in the interim) they are not bothered.

If you do not put money aside to buy the property at the end of 25 years then you need to find that cash quickly. The only option is to SELL the property to get the cash to buy the property

SO ARE THEY GOOD THINGS?

Well let's see

YEAR 2000

House is £100,000 over 25 years @5%

Repayment £591.27

Interest Only £416.66

Saving of £174.61

But you then have to find a GOOD investment to try and get that £100,000 to pay the bank in 25 years time.

If you saved £174.61 every month for 25 years it comes to £52,383 so then the balance is reliant on INTEREST on you investment. As we know, the bigger the risk, the bigger the gains.

The simple fact is, YOU ARE STILL PAYING £591.27 P.C.M. so its NOT a cheaper way of buying a house. If you paid REPAYMENT you are guaranteed that the house is yours NO MATTER WHERE IR OR THE STOCKMARKET GOES!!!

This is as big a scam as ENDOWMENTS. The only way I/O's are any good is for BTL. Pay the mortgage, get the rent to cover the mortgage payments and hopefully a little bit more and then let HPI sort out the profit.

To anyone buying a HOME to live in? STAY WELL CLEAR!!!

On a lighter note: There is another way of doing an I/O Mortgage.

Pay the I/O and invest in BUCKETS because before long there will be a lot of people crying in them!!

[Given Up]

They can only take the house if you either fail to pay the interest, or at the end of the IO period, fail to pay the principal back.

You can take an IO for wahetever period you chose and the loan is secured against the house. So if you took it for 10 years and at the end could not pay back the loan, the bank would sell the house. If they got less than the loan, you would owe the differnce. If you did not have it you could declare yourself bankrupt.

[CrashBear]

They can only take the house if you either fail to pay the interest, or at the end of the IO period, fail to pay the principal back.

You can take an IO for wahetever period you chose and the loan is secured against the house. So if you took it for 10 years and at the end could not pay back the loan, the bank would sell the house. If they got less than the loan, you would owe the differnce. If you did not have it you could declare yourself bankrupt.

so if there was a house price correction in your area and you wanted to sell you'd be pretty much screwed unless you had saved up the cash for the loan?

Edited March 20, 2006 by CrashBear

[Ignorant Steve]

What a pleasing story

I thought an I/O Mortgage is the borrowing of the money and not the asset? IE Even if house prices HALVE! then the bank will be happy as long as the payments are met. As far as I know they cannot take the house because you do not own the house. They can at any stage they feel fit call in the loan if you default but as long as you give them back what you borrowed 25 years earlier (plus the 0000000's of pounds of interest in the interim) they are not bothered.

If you do not put money aside to buy the property at the end of 25 years then you need to find that cash quickly. The only option is to SELL the property to get the cash to buy the property

SO ARE THEY GOOD THINGS?

Well let's see

YEAR 2000

House is £100,000 over 25 years @5%

Repayment £591.27

Interest Only £416.66

Saving of £174.61

But you then have to find a GOOD investment to try and get that £100,000 to pay the bank in 25 years time.

If you saved £174.61 every month for 25 years it comes to £52,383 so then the balance is reliant on INTEREST on you investment. As we know, the bigger the risk, the bigger the gains.

The simple fact is, YOU ARE STILL PAYING £591.27 P.C.M. so its NOT a cheaper way of buying a house. If you paid REPAYMENT you are guaranteed that the house is yours NO MATTER WHERE IR OR THE STOCKMARKET GOES!!!

This is as big a scam as ENDOWMENTS. The only way I/O's are any good is for BTL. Pay the mortgage, get the rent to cover the mortgage payments and hopefully a little bit more and then let HPI sort out the profit.

To anyone buying a HOME to live in? STAY WELL CLEAR!!!

On a lighter note: There is another way of doing an I/O Mortgage.

Pay the I/O and invest in BUCKETS because before long there will be a lot of people crying in them!!

In your example above if you saved £174.61 a month for 25 years and got a return of 5% a year you would have your £100,000 lump sum. How much do ING pay? almost 5% - What did the SM return on average over any 25 year period? 8%??.

If you got a 7% return over 25 years youre monthly saving of £174 would be worth approx £132,000.

[AteMoose]

In your example above if you saved £174.61 a month for 25 years and got a return of 5% a year you would have your £100,000 lump sum. How much do ING pay? almost 5% - What did the SM return on average over any 25 year period? 8%??.

If you got a 7% return over 25 years youre monthly saving of £174 would be worth approx £132,000.

however because your not paying the capital off on the morgage, your IO repayments will be higher for longer, and offset this investment. You would want alot better than 5%..... 10->15% would cover things....

[MarkG]

And don't forget that any investment return will presumably be taxed, even though the money you invest is taxed already. 40% tax on that 132k would leave you unable to pay off the house after that 25 years of investing.

[Ignorant Steve]

however because your not paying the capital off on the morgage, your IO repayments will be higher for longer, and offset this investment. You would want alot better than 5%..... 10->15% would cover things....

You really don't understand do you. For both mortgages the monthly repayments will only change if the interest rate changes.

I've just shown how a 7% return would give you approx £132,000 to pay off a £100,000 lump sum. This is perfectly acceptable.

A 10% return would give you approx £206,000 and 15% would give you a massive £445,000.

And don't forget that any investment return will presumably be taxed, even though the money you invest is taxed already. 40% tax on that 132k would leave you unable to pay off the house after that 25 years of investing.

Ever heard of an ISA?

[AteMoose]

Nahh you dont get it.... Re the CML data, were still at 18%

[y0ssarian]

It looks like IOs are just endowments with the investment part removed

What I cannot believe is that banks are willing to lend without some sort of assurance that the capital can be repaid

I disagree that banks wont mind if the underlying asset(house) falls in value against the loan

this doesnt make sense,

When a bank makes a loan they take ownership of that property (which is why the title Homeowner is such a joke) and it offsets their liabilities. If the value of a banks assets (the deeds it now holds) falls because of a housing slump against its outstanding liabilities (money lent out as mortgages) they fall outside or regulations. A bank must have a certain asset value backing its liabilities.

For this reason when asset prices drop banks wont just sit on their laurels, they will turn the thumb screws.

and most probably a lot of people will just hand in the front door keys and walk away.

the banks arnt stupid they are lending out paper through frational reserve lending in exchange for hard asses like property and making joe public slog his guuts out just to make interest payments.

Does anyone here actualy know if you can take out an IO now without showing a commitment of some sort outsid of the mortgage to pay back the capital, there seems to be some disagreement.

are there no bank managers here??

Edited March 20, 2006 by y0ssarian

[teddyboy]

You really don't understand do you. For both mortgages the monthly repayments will only change if the interest rate changes.

I've just shown how a 7% return would give you approx £132,000 to pay off a £100,000 lump sum. This is perfectly acceptable.

A 10% return would give you approx £206,000 and 15% would give you a massive £445,000.

Ever heard of an ISA?

Ok educate me here - Is an I/O Morgage FIXED?

If not, when you done a savings account you are quoting a return of 7% (I know this is an average and speculative). But would your payments not go up also?

Lets say that IR dropped to 3% then the return on the savings will fall short> But would there be enough savings on your mortgage to put into the savings part?

It does not matter whether you make money or lose money. My thought it is this.

PEOPLE ARE BEING CONNED INTO TAKING I/O MORTGAGES BECAUSE THEY ARE CHEAPER AND THEY BORROW MORE MONEY!

The truth is they are NO CHEAPER!!!

They are riskier - I would play it safe with a replayment every time!

ENDOWMENT SCAM PART 2: Coming to a newspaper near you!!

[Tempest]

It looks like IOs are just endowments with the investment part removed

What I cannot believe is that banks are willing to lend without some sort of assurance that the capital can be repaid

I disagree that banks wont mind if the underlying asset(house) falls in value against the loan

this doesnt make sense,

When a bank makes a loan they take ownership of that property (which is why the title Homeowner is such a joke) and it offsets their liabilities. If the value of a banks assets (the deeds it now holds) falls because of a housing slump against its outstanding liabilities (money lent out as mortgages) they fall outside or regulations. A bank must have a certain asset value backing its liabilities.

For this reason when asset prices drop banks wont just sit on their laurels, they will turn the thumb screws.

and most probably a lot of people will just hand in the front door keys and walk away.

the banks arnt stupid they are lending out paper through frational reserve lending in exchange for hard asses like property and making joe public slog his guuts out just to make interest payments.

Does anyone here actualy know if you can take out an IO now without showing a commitment of some sort outsid of the mortgage to pay back the capital, there seems to be some disagreement.

are there no bank managers here??

No - this thread is full of confused thinking and incomplete knowledge.

The bank does NOT take ownership of the property. They have a mortgage (ie a charge) which they can enforce if you default on repayment - the property acts as security for the loan. They tend not to do this unless absolutely necessary (eg many months defaulting - although that can change depending on prevailing economics). Whether you take an IO or repayment mortgage you cannot lose your house if you meet the payments. This could only happen if the bank included an LTV (loan to value) ratio in the mortgage - only usually seen in commercial property lending or lending to non-OO portfolios/BTLs. There if the value sinks below the threshold they can often ask for collateral or payment to make up the ratio or take the property - again they would normally explore all other options first.

This is nothing to do with fractional reserve/reserve lending or regulations governing capital adequacy and banks needing certain amount of liquid assets to support their liabilities - that does not relate to the security for a particular loans but to do with the amount of capital which banks must retain to meet depositors liabilities in the short term (ie to meet the bank's obligations to repay "loans" to the bank from depositors of cash in current/savings accounts).

A bank lends money via a mortgage - a loan is created - that (in the hands of the bank) is an ASSET and in your hands is a LIABILITY. They balance each other out in accounting terms unless provision has to be made for bad debts.

A bank does not care about asset value as long as the loan is repaid (although as I say they may be more sensitive in a HPC scenario if you fall behind than in a HPI scenario). The requirement for capital repayment vehicle is not waived by banks but they can sometimes rely on a statement that you have one without checking. That is merely market forces at work and banks deciding to lend despite the risk. Yes it may come home to roost for those who make no provision later on.

Also, many banks and lenders increasingly package up their residential loans into portfolios of thousands of loans which are sold to bond investors - there the risk of default and the risk of assets not being of sufficient value to support the loans is passed to the investors - allowing the bank to start again without the worry of those loans turning "bad" and affecting the bank's balance sheet and thus its ability to lend.

[frugalista]

Hmmmm - My brother in law and his wife are banking on their 'inheritance' to pay of their lie-to-buy / interest only / no endowment / reliant on 'inheritance' / leasehold / buy at the top of the market mortgage.

They have really p'd my husband and me off over the past few years. They have been trying to get us to buy for a long time - they think we're childish and foolish for renting. They don't have a proper job between them - one is a jobbing actor, the other a stay at home mum (fair enough). They made a small profit on a flat they had in london - paid of their credit card debt, then bought again last May

The reason they p'ss me off so much is the fact that they think they're some kind of investment gurus - they even offered to come round to see us to help us buy somewhere - what they meant was tell us how to lie to the bank to pretend we're on incomeX ,apply for an interest only mortgage & buy at the top.

I don't know whether they:

A Do, GENUINELY believe they are property developers who are going to make a massive profit on their hideous house and want us to have the same (i don't think so)

or

B Are more Machiavelian than that, and just want us to be in the same boat as them (safety in numbers etc - Crash Gordon won't let house prices go down - it would affect too many people, kind of mentality)?

Anyway - my husband has been compliling his superb "HOUSE PRICE CRASH COMPENDIUM PARTY PACK" for the past 4 years - it's going to be so pleasurable to invite the gloating b'strd's round when the crash is well and truly underway and show them that we haven't been quite as ignorant as they thought we were...

wifeling-smi -- I sense you may be turning to the dark side.

frugalista

[A Fool & His Borrowed Money]

Has anyone here taken out an interest only mortgage?

I would be grateful if someone could explain to me what is involved with taking out an interest only mortgage pls,

are you required to have some form of investment scheme to make the payback on the capital sum?

surley they dont just let you pay the interest and dont worry how you will payback the capital loan at the end?!

whats the different between interest only and an endowment??

Cant be bothered reading through the thread, but if no-ones mentioned it , it goes like this: -

Every 1 pound you pay on the mortgage, every one pound goes to the bank. No money is spent on repaying the loan back, all of it is on paying Interest charges. Hence the name "Interest Only". At the end of the term you are supposed to have also saved up enough to pay off the capital, if not, you sell the house to repay.

In short; renting the loan

Edited March 20, 2006 by A Fool & His Borrowed Money

[Tempest]

They can only take the house if you either fail to pay the interest, or at the end of the IO period, fail to pay the principal back.

You can take an IO for wahetever period you chose and the loan is secured against the house. So if you took it for 10 years and at the end could not pay back the loan, the bank would sell the house. If they got less than the loan, you would owe the differnce. If you did not have it you could declare yourself bankrupt.

Note that, if you declare bankruptcy then the bank/lender can still pursue you after discharge of the bankruptcy if the loan was secured (secured loans and student loans among others can be chased after bankruptcy!). ie they can still attach to other assets, wages etc etc and chase down the loan years later. Quite rightly. I am not subsidising people who seek to avoid their responsibilities by declaring bankrutpcy where they have been (naive/stupid) homeowners.

Also, any investment products formally attached to the loan (eg endowments) are secured to the bank with the house and they can take those too...

[apom]

thanks for the replies, though I know already what an endowment policy is, what im looking for is an explanation on what an interest only mortgage involves

if you take out an interest only mortgage does the bank make sure you have some kind of an investment that will pay off the capital or do they just ask for the interest payments and let you work out how you will pay the capital?

I dont want one my self, im just curious to know what the situation is for all the people taking out interest only mortgages.

almost without fail an interest only mortage has a little box you tick where you agree that you have set up a repayment vehicle to pay of the capital.

[homeless]

i wonder how responsible the amount of IO mortgages been done is for the house price bubble we have just been through.

people able to loan more than they would nhave before with repayment is surely some way responsible for the silly prices we have seen.

[ryanjw]

Could I just change the subject for a sec.

Alliance & Leicester`s 5 yr fixed rate says it allows a 10% overpayment facility.

Does this mean you can overpay by 10% every year or just 10% over 5 years?

When would a fee be enforced?

I don`t understand the way the penaltys work

Edited March 20, 2006 by ryanjw

[Guest Charlie The Tramp]

You never 'pay off' an interest-only mortgage. That's the whole point: you only pay the interest, and at the end of the mortgage you still owe exactly as much as you did at the start.

An interest-only mortgage is a bet that house prices will inflate enough to cover the cost difference between mortgage and rent.

You then downsize taking the profit to clear the original loan in 20 to 25 years time. This will mean that hundreds and thousands of properties come on to the market causing another HPC.