A Good Use Of Io Mortgages

[tekken]

Hello all,

Please bear with me, as I'm no expert when it comes to mortgages. I'm looking to buy a property. Anyway, over that last 18 months or so, I have become very good at saving and not wasting my money. I have developed some self-control that has meant that I can save really well. Would it be better for me to get an IO mortgage, and keep on saving my average 600-1000 per month (that's after £500 rent, bills, car, social, etc...) to make lumpsome payments on the mortgage?

Does that seem like a good idea? My initial monthly payments will be lower, and I can focus on saving. Now, with an IO mortgage, can I make as many payments to the principal debt as I want? For example, I sometimes get involved in projects that require me to do lots of extra time, therefore some months I will have a fair amount of cash that I could pump in the repaying the house. Does this seem like a sensible way to go? I think I understand the potential pitfalls with this system, but it seems like the benefits are far greater and out weight the negative. I know that this kind of system is a real test of character, but I firmly believe that I can do it.

The reason why I thought about this, was down to a friend showing how much of the principal loan is actually paid in the first 10 years of the mortgage on a repayment mortgage- very little!!! I was shocked.

Any advice would be great.

Tekken

[RandomWalk]

tekken

For the financially diciplined, I think that IOs are fine - indeed I would consider one when I next buy

If you can control youself then there are no pitfalls in my opinion. If I had one, I'd value the lower monthly obligation, whilst squirelling away each month in overpayments. This is how I'd use an IO rather than an accompanying investment vehicle (I have other stock market investments so wouldn't want to pin every aspect of my financial future on Mr Market).

You do of course get a very good (risk free) effective return on your money using the overpayment route i.e. the interest rate of the IO factored by your marginal rate of tax.

All that said, I personally know of few people who are financially diciplined enough for an IO

mjd

[Golden Shower]

As stated, it depends on how well you stick to your plan. Also try to consider what would happen if prices did drop, would it make the cost saving worth while.

I think IO mortgages are unfairly cast in a bad light, I think they are actually quite good if you play them well.

[enworb]

For someone like you an interest only mortgage is a good idea. It saves struggling for the first couple of years which is what some do with a repayment mortgage.

Be aware though that some lenders will not allow overpayments without charging an admin fee or fine so make sure you ask when applying.

The only advice I would give is to avoid new build flats and look for a resale that needs a lick of paint.

[SarahBell]

Hello all,

The reason why I thought about this, was down to a friend showing how much of the principal loan is actually paid in the first 10 years of the mortgage on a repayment mortgage- very little!!! I was shocked.

Any advice would be great.

Tekken

In the first 10 years of an IO mortgage surely NO capital repayment happens at all and you have to save for this as well?

You should take proper financial advice for your circumstances and understand the pros and cons of both types and see which suits your needs best.

[bearwithaconscience]

If you save the money, where are you going to put it that offers a larger rate of return than you are paying in mortgage interest? The general rule of thumb is always to pay off your debts before saving. Your better option, depending on your tax status, might be to put all your savings in an offset mortgage. That way you reduce your interest and you can get access to this money, despite the nominal property price.

If you are a higher rate taxpayer this will really work for you, but even on standard rate you will benefit. The better offset mortgages don't charge an admin fee for overpayments. Why not try a "one" account or similar?

[the gardener]

Sounds like a perfectly reasonable idea to me.

I have considered doing the same - going for a higher IO mortgage than I would with a repayment in order to buy a bigger family house now and then overpaying more when the wife returns to work.

If you do this I would recommend an offset mortgage where a savings account is linked to the mortgage. You can overpay all you like into this savings account and it reduces the interest paid on the mortgage. If you were to pay in the difference between the repayment amount and the interest only amount then effectively you would have a repayment mortgage but without the obligation to actually hand over the full repayment amount. These savings could then be available in case of emergency / bad times, such as job loss.

You do need to be disciplined though because you could be lulled into thinking that you have a lot more money than you really do.

If the figures add up then go for it.

[AteMoose]

why not go for a long term morgage say 35 years... but continue to save, at the end of each year you can overpay anything you have saved best of both worlds. Using an IO morgage and reducing the amount every year is a good idea except you will have missed out on a year months of a lower morgage and it will cost you in the long run, reducing your morgage every month is a good idea...

Alternativly get an offset bank account/morgage then your daily savings will reduce your morgage..

Edited July 19, 2006 by moosetea

[bearwithaconscience]

If you are planning to pay off the mortgage at all, then you are better off doing it in as short a period as possible, rather than stretching it out. The only way an interest only mortgage makes sense is in a rapidly rising market, or when inflation is eroding away the capital. Neither of these seems likely at the moment, but this might change.

Having said that, if you are happy to take that risk in the area you live in (bearing in mind there is no such thing any more as the "UK housing market" - it is very parochial), then an interest only could make sense if you expect your income to shoot up at some future stage, but think that by then prices in your area might have gone out of reach. Be aware of the risks though. If at some point in the future, confidence in rising prices drops, then people after you will be reluctant to take out IO mortgages. This could double up with higher interest rates to mean that you took out too much debt at the very wrong time. Be careful, an IO mortgage is a very long term committment.

What an IO mortgage does is give you the illusion of flexibility. Make sure you area clear about the benefits and drawbacks of this.

[Tempest]

Depends on how much you consistently save per month and how much your salary is projected to rise over the next 10 years (not due to inflation but due to the natural salary progression (if any) in your line of work). The overpayment/lump sum payment route is one of the best investments you an make, esp if you are a higher rate taxpayer (a 40% taxpayer would need to find a safe investment return of around 10% or more pa to beat the mortgage interest rate and that is without CGT factored in.

If you are only saving £500-£1000 per month now and in the future (I say "only" - it is a lot I know) you may find that a repayment mortgage with a long fixed rate is fine as most repayment mortgages will allow monthly overpayments of £500, sometimes nearer to £1000. Worth checking.

The IO route is excellent too if you are disciplned. It is ideal if you expect to save £1000 or more per month or if your salary includes a large bonus element payable at certain period(s) throughout or at the end of the year. You can really shorten the mortgage with these. I will be taking out an IO mortgage next having done repayment mortgages to date - this is because I am saving £1500 a month and now benefit from a large annual bonus structure which will increase as I go on.

You can also take out a fixed rate IO mortgage. Fix rate for 2 years say (rates are only going up!) and in addition to the direct debit to pay the interest you set up a standing order to overpay the maximum that your mortgage will allow (say £500 per month). You chuck the rest of your monthly savings in an ISA or similar and when the fixed rate expires you repay the lump sum you have saved and either continue at base rate or refix for another year or two. Slightly less optimised than the floating IO route but is a neat way of getting the best of both worlds and still shortening the mortgage hugely. I may do something like this although I may split my mortgage so that 50% is fixed rate repayment and 50% is IO. That way I am not exposed on the fixed element but can overpay the IO element (few people will have the cash to repay the entire mortgage in a few years anyway so this is a good hedge).

Edited July 19, 2006 by Tempest

[Ignorant Steve]

Depends on how much you consistently save per month and how much your salary is projected to rise over the next 10 years (not due to inflation but due to the natural salary progression (if any) in your line of work). The overpayment/lump sum payment route is one of the best investments you an make, esp if you are a higher rate taxpayer (a 40% taxpayer would need to find a safe investment return of around 10% or more pa to beat the mortgage interest rate and that is without CGT factored in.

If you are only saving £500-£1000 per month now and in the future (I say "only" - it is a lot I know) you may find that a repayment mortgage with a long fixed rate is fine as most repayment mortgages will allow monthly overpayments of £500, sometimes nearer to £1000. Worth checking.

The IO route is excellent too if you are disciplned. It is ideal if you expect to save £1000 or more per month or if your salary includes a large bonus element payable at certain period(s) throughout or at the end of the year. You can really shorten the mortgage with these. I will be taking out an IO mortgage next having done repayment mortgages to date - this is because I am saving £1500 a month and now benefit from a large annual bonus structure which will increase as I go on.

You can also take out a fixed rate IO mortgage. Fix rate for 2 years say (rates are only going up!) and in addition to the direct debit to pay the interest you set up a standing order to overpay the maximum that your mortgage will allow (say £500 per month). You chuck the rest of your monthly savings in an ISA or similar and when the fixed rate expires you repay the lump sum you have saved and either continue at base rate or refix for another year or two. Slightly less optimised than the floating IO route but is a neat way of getting the best of both worlds and still shortening the mortgage hugely. I may do something like this although I may split my mortgage so that 50% is fixed rate repayment and 50% is IO. That way I am not exposed on the fixed element but can overpay the IO element (few people will have the cash to repay the entire mortgage in a few years anyway so this is a good hedge).

Couldn't agree more. This is exactly what we, as two higher rate tax payers are doing.

5 year fix at 4.69%. Part IO, part repayment.

We aim to clear mortgage in a maximum of 10 - 12 years. Should be over-paying by approx 10% per year.

[shamrock1]

Hello all,

Please bear with me, as I'm no expert when it comes to mortgages. I'm looking to buy a property. Anyway, over that last 18 months or so, I have become very good at saving and not wasting my money. I have developed some self-control that has meant that I can save really well. Would it be better for me to get an IO mortgage, and keep on saving my average 600-1000 per month (that's after £500 rent, bills, car, social, etc...) to make lumpsome payments on the mortgage?

You are always better paying the extra money directly into the

mortgage rather than a saving account *unless* you are able to find

a savings account which gives a higher rate of interest than the rate

charged by your mortgage (+ any extra charges).

[or if you have some master plan to make some great investment

which you will use to pay off the capital]

If you are saving all this money every month the right thing

to do is to take out a repayment mortgage and shorten the mortgage

term so that you are paying more in each month.

You can use the calculator at the following website to see how this

works:

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

The only reason this wouldn't work is if for some reason you can't

guarantee you'll always have 600 per month. If your income/situation

is likely to change you wouldn't want to commit to a mortgage of 15 years

(or whatever you decide). Then your original plan of choosing an I/O

or a standard-length mortgage is a safer way to go.

Edited July 19, 2006 by shamrock1

[padders]

I would have thought a repayment offset mortgage would be a better bet for you. The idea here is you can overpay by simply putting money in your current account you have with them. So the months you make lots of money put lots into your current account (just think of this as paying off the house) and the months you earn less, no worries, the mortgage will just come out from that current account and you will have less "surplus".

When I buy, this is what I plan to do (being self employed, same sort of situation).

[the gardener]

With an offset mortgage you don't have to chase around for the best savings rate. The rate is the same as the mortgage rate you pay. It is also tax-free as you aren't actually recieving interest just reducing the debt interest you pay.

I am currently on my 3rd offset mortgage - first got one in 1999. I recommend them to everyone as long as you are financially disciplined.

[padders]

Also, if you got for an offset, look into IF. They are one of the few places that offset ISAs. This is good because it means you can keep money in the tax free ISA so that when your mortgage is paid off you can continue to benefit from tax free savings. Had the ISA not been counted it would have been better to take the money out of them to repay the mortgage.

(Assumes ISAs still exist when mortgage is paid of course!)

[Tonester]

My mortgage is 4.99% (repayment), taken out 2.5 years ago.

If I have £1000 then the options I look at are:

1) Put in Cash ISA

2) Put in Stocks ISA

3) Pay off mortgage

4) Do nothing

I did 1 for a couple of years because ISA rate was 5.4% (so better than paying off mortgage at 4.99%) and I didn't know enough about stocks and shares. Started 2 recently - badly timed for recent correction (I guess I still don't know enough about S&S!) so I've taken a step back (4) and started doing 3.

With hindsight, if I had taken out an IO mortgage and invested more in stocks back then I would be in a much better situation.

If you are disciplined at saving, and willing to put in some time looking into investment then IO mortgages are a good option.