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greengreen

Would Io Be Hit Harder Than Repayment On Interest Rate Rise?

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This may seem obvious to some of you, but having gone to have a look at a mortgage caculator at:

http://money.guardian.co.uk/calculator/for...,603156,00.html

and if I enter the following:

200K loan at 5% over 25 years

IO payment would be £833.33

Repayment would be £1169.18

the same loan at 6%

IO payment would be £1000 - A rise of £166.67

Repayment would be £1288.60 - A rise of £119.42

the same loan at 7%

IO payment would be £1166.67 - A rise of £333.34

Repayment would be £1413.56 - A rise of £244.38

Effectively if people are on an IO mortgage the rise would be larger than on repayment. I would imagine that if they were on an IO and they were saving into something else to pay off the balance, then at higher interest rates the return on their savings could/would be larger. If an IO mortgage was based on ability to pay at current rates, a raise in rates would significantly affect them.

Does this make sense? or where are the gaping holes in this argument.

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Sounds about right, that is why for many a decade we had to repay our mortgage and decide what we could afford based on repaying it!

Repayment mortgages also have the benefit of building up equity and can help insulate you from downward price movements (even though they never occur :P).

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Effectively if people are on an IO mortgage the rise would be larger than on repayment. I would imagine that if they were on an IO and they were saving into something else to pay off the balance, then at higher interest rates the return on their savings could/would be larger. If an IO mortgage was based on ability to pay at current rates, a raise in rates would significantly affect them.

Does this make sense? or where are the gaping holes in this argument.

I think that the problem is that people are buying with IO mortgages because that is the only way they can afford them. Therefore interest rate rises will probably mean that when the fixed rate deals have finished they will find that they can't afford them. This should start to happen in the within the next 2-3 years, all depends on inflation and interest rates but my betting is they are going up.

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I think that the problem is that people are buying with IO mortgages because that is the only way they can afford them. Therefore interest rate rises will probably mean that when the fixed rate deals have finished they will find that they can't afford them. This should start to happen in the within the next 2-3 years, all depends on inflation and interest rates but my betting is they are going up.

Would you agree if I rephrase your argument as:

People on IO mortgages generally choose them because that's all they can afford. Therefore, on average, a larger part of their disposable income is being paid out as mortgage interest compared to those on repayment mortgages. Therefore people on IO mortgages will be hit harder than those on repayment mortgages because if the amount they pay in interest goes up by a fixed percent, then that's a larger increase in terms of the percentage of their disposable income compared to those who are on repayment mortgages.

Or, in numbers. If two people earn 2K a month, and pay out 1K in mortgage payments. Both have mortgages as 5%. Assume that person1 is on repayment, and is paying out £200 repayment and £800 interest per month. Person2 is paying out £1000 per month interest, and has no repayment vehicle in place. Person1 then has a £192K mortgage, and person2 has a £240K mortgage. If the interest they pay on their mortgage goes up from 5% to 5.5%, then the repayment goes up to £1080. The IO payment goes up to £1100.

However, there is a kicker here. As the repayment person keeps paying off the principle sum, the amount they pay in interest goes down. As the years go by, they become more and more insulated against interest rate changes. The IO mortgage person does not.

I did this quickly, so these numbers and/or methods might be wrong. Well, they could be wrong anyhow, but it's more likely than usual.

Billy Shears

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Essentially, if you take a IO mortgage, it' for one of the following reasons

1) You reckon on making a sufficient capital gain on the property so that you clear a profit after transaction costs when you sell.

2) Your income going up so you can move to a repayment basis in the future; only relavent if you believe that house prices will rise in the future, and therefore it is worth fixing the price now.

3)You are stupid, beacuse you have failed to realise you have fixed your rent to the bank to the interest rate.

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there is another option (though not that popular I hazard) that an IO mortgage frees up the repayment proportion to allow you to build a warchest to get through higher interest payments and out the other side - if you have paid down the debt, that cash is gone, if you still have it, you can use it to service the debt.....

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However, there is a kicker here. As the repayment person keeps paying off the principle sum, the amount they pay in interest goes down. As the years go by, they become more and more insulated against interest rate changes. The IO mortgage person does not.

I've just been looking at mortgages as my sister is looking to buy.

£170K mortgage, IO approx £800, repayment approx £1050

Total repayable over 24 years;

IO: approx £450K

repayment: approx £325K

so for £250 extra per month you are saving over £100K over 25 years.

IO mortgages really shouldn't be allowed. This is one area the government should intervene.

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Essentially, if you take a IO mortgage, it' for one of the following reasons

1) You reckon on making a sufficient capital gain on the property so that you clear a profit after transaction costs when you sell.

2) Your income going up so you can move to a repayment basis in the future; only relavent if you believe that house prices will rise in the future, and therefore it is worth fixing the price now.

3)You are stupid, beacuse you have failed to realise you have fixed your rent to the bank to the interest rate.

This has given me an idea - why NOT rent money from the bank? Take out a 10, 15, 20 year fixed rate IO mortgage. You have effectively fixed your rent for the next 10-20 years. If you rent from a landlord, you will probably have to pay increasing rent over time.

If you can be sure that you want to live somewhere for the foreseeable future, is this a bad thing?

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there is another option (though not that popular I hazard) that an IO mortgage frees up the repayment proportion to allow you to build a warchest to get through higher interest payments and out the other side - if you have paid down the debt, that cash is gone, if you still have it, you can use it to service the debt.....

yeah and who do you think is doing this?

the fact that the increase in IO mortgages correlates with the increase in house prices suggests that it is because people have decided they can't afford the repayment mortgages and therefore is very unlikely that any of these are putting extra money aside!

If you are taking out an IO mortgage at this stage of the cycle you are asking for trouble - you can't afford a house and you should accept that.

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IO mortgages really shouldn't be allowed. This is one area the government should intervene.

I see your point, but let's say you are NQ accountant or professional on £35K, you 'know' you will be on £50K in three years and probably £100K three to five years after that - surely it makes sense to be able to push yourself now to get on the ladder [if rent is more than mortgage interest [dream on in most places]]....

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This has given me an idea - why NOT rent money from the bank? Take out a 10, 15, 20 year fixed rate IO mortgage. You have effectively fixed your rent for the next 10-20 years. If you rent from a landlord, you will probably have to pay increasing rent over time.

If you can be sure that you want to live somewhere for the foreseeable future, is this a bad thing?

My rent has fallen 7% over the last 3 years (i.e. no increases so falling in real terms)

UK spending is being squeezed and will get worse - student average debt expected to be £30K after introduction of tuition fees.

Two of my sisters have moved home to save money, moved out of rented accomodation.

Personally I don't see any pressures on rent on the horizon, quite the opposite. I think rents could continue to fall for years, more young people will be forced to stay at home to pay off debts.

I see your point, but let's say you are NQ accountant or professional on £35K, you 'know' you will be on £50K in three years and probably £100K three to five years after that - surely it makes sense to be able to push yourself now to get on the ladder [if rent is more than mortgage interest [dream on in most places]]....

Then that would be fair enough and I'm sure there are a few making this presumption.

but, as I said the fact that the rise in IO correlates with the rise in prices suggests it is affordability constraints that mean people can't afford repayment. There will be many, and remember average FTB is now 34 - that won't be earning much more in the future. Your 30's are generally where you find your peak earning potential.

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there is another option (though not that popular I hazard) that an IO mortgage frees up the repayment proportion to allow you to build a warchest to get through higher interest payments and out the other side - if you have paid down the debt, that cash is gone, if you still have it, you can use it to service the debt.....

Yes, but we're discussing people who take out IO mortgages because that's all they can afford. That's why I fixed the payments for both people in my version of minimula's example at 1K per month. I was assuming that this was all that the people could afford. So, for the IO mortgage victim in my example, there is no repayment vehicle and no additional money left over to service one.

What percentage of people who have recently taken out IO mortgages would you estimate have a repayment vehicle in place?

Billy Shears

This has given me an idea - why NOT rent money from the bank? Take out a 10, 15, 20 year fixed rate IO mortgage. You have effectively fixed your rent for the next 10-20 years. If you rent from a landlord, you will probably have to pay increasing rent over time.

If you can be sure that you want to live somewhere for the foreseeable future, is this a bad thing?

Your plan might work, but depends on a lot of assumptions.

What about maintenance, won't you be liable for maintenance and building insurance costs over that time. You're exposed to the risk of negative equity. Given recent history negative equity is unlikely, but society may be very different in 25 years. We've seen generally rising land costs for a long time, but there's no guarantee this would continue. It's difficult for you to move house, especially if your in negative equity at the time. What happens if they build a nuclear power station next door and it starts leaking?

But most importantly, there might be very much better times in the next five years or so to execute your plan, fixing your rent for a lower amount.

Billy Shears

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This has given me an idea - why NOT rent money from the bank? Take out a 10, 15, 20 year fixed rate IO mortgage. You have effectively fixed your rent for the next 10-20 years. If you rent from a landlord, you will probably have to pay increasing rent over time.

If you can be sure that you want to live somewhere for the foreseeable future, is this a bad thing?

This is a terrible idea.

If you want to move and the house price goes down you are in negative equity.

If you rent, you have no commitments, you are free!

Edited by Pluto

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I would imagine that if they were on an IO and they were saving into something else to pay off the balance, then at higher interest rates the return on their savings could/would be larger. If an IO mortgage was based on ability to pay at current rates, a raise in rates would significantly affect them.

I dont think people are even doing that. Whenever I've recently read 'financial advice' columns about getting on the propertydebt-ladder, they recommend IO mortgages and suggest that the dupe asking for advice changes it to repayment later, 'when they can afford to'.

With higher IRs hitting IO mortagees harder, that 'when you can afford to' will be never

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The real rise in the cost of living for most is far outstrippping earnings increases (unless decent promotion is occuring). IO is a killer under these circumstances.

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  • 301 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
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      • up 5%



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