Why Interest Only Mortgages?

[Josemartinez]

I saw Interest Only Mortgages mentioned on another thread and didn't want to derail it so thought I'd start another

I don't really understand the purpose of them. Me and my wife looked at changing to interest only during covid as we only had 1 income at the time and the payments weren't that much lower.

So what is the point of them? It just seems to be me your putting off paying off your mortgage and paying a fortune in interest for the privilege. The banks must love them.

[blue_haddock]

Years ago you would buy an endowment policy which in theory grew quicker than the mortgage payment so not only would it pay it off in a few years but you'd also have a chunk of cash.

Then people realised the endowment was nowhere near what was predicted so the mortgage wasnt paid off and there was no chunk of money either.

They are also used on buy to lets so the mortgage is cheaper, and as its never deigned so you own your own home in a few years when you decide to stop being a landlord you sell the property and pocket the difference between the mortgage amount and what the property is now worth.

[CMTMB]

It enables people to borrow more and pay less. It suits many people working and living in London. E.g. buy a £1M property with £500k on interest only. They then retire and downsize to a £500k home outside London mortgage free.

Or, it's investment linked because they think they can make the money work harder elsewhere.

[alscar]

CMTMB said:

It enables people to borrow more and pay less. It suits many people working and living in London. E.g. buy a £1M property with £500k on interest only. They then retire and downsize to a £500k home outside London mortgage free.

First sentence broadly and also flexibility.
We did this back in 2004 and was the only way I could afford the repayments on a" silly "mortgage.
That said it also gave me the flexibility to pay off lump sums over the following 3 years and indeed clear the mortgage within 5 using bonus payments that took some time to come in.

[Peterpetrole]

Josemartinez said:

I saw Interest Only Mortgages mentioned on another thread and didn't want to derail it so thought I'd start another

I don't really understand the purpose of them. Me and my wife looked at changing to interest only during covid as we only had 1 income at the time and the payments weren't that much lower.

So what is the point of them? It just seems to be me your putting off paying off your mortgage and paying a fortune in interest for the privilege. The banks must love them.

1) You're going to be "paying a fortune" in interest with either repayment or interest only mortgages.
2) On a repayment mortgage you are betting that house price growth will outstrip other investment returns over the period. Which admittedly has been true for a fair chunk of the past 50 years, but hasn't been true for the past 3.
3) Hence makes no difference to the banks either way, they don't have a preference and will get the same return on their money regardless.

[TheK1981]

My ex did an interest only mortgage after uni, cost was the same as rent, as she passed exams and got payrises she started overpaying, worked better as people she worked with was looking at places and the prices had jumped so much in milton keynes they bought flats for the same price as she paid for a 2 bed house

[Harry H]

I have an interest only mortgage.

4 yrs ago I managed to get a fix at 1.6%. So costs around £200 a month

I have savings to pay it off which earn me around £450 a month.

For my own satisfaction the savings are with the same bank as the mortgage.

As you can imagine I'm not in a rush to pay it off although the fix ends next year which means I'll have to. It was a blast whilst it lasted though.

[98elise]

Instead of paying down the mortgage you can invest the cash.

I have an IO mortgage and do exactly that. I'm on a 5 year fix at about 2% so thats all I'd be saving by paying the mortgage down. In equities (mostly funds) I'm getting many multiples of that.

The majority of BTL mortgages are also IO.

[FlyingPanda]

98elise said:

Instead of paying down the mortgage you can invest the cash.

I have an IO mortgage and do exactly that. I'm on a 5 year fix at about 2% so thats all I'd be saving by paying the mortgage down. In equities (mostly funds) I'm getting many multiples of that.

100% this. My circumstances exactly.

[Harry H]

And don't forget the effect of inflation reducing the the value of the loan by say 3.5% a year. In 20 years time the cost to pay it off in most instances won't even buy a mid range car.

As long as you plan around it they offer far more flexibility and can be a great deal. They do require a bit of personal discipline so not for everyone.

Edited by Harry H on Monday 23 February 10:40

[Josemartinez]

Thanks all, that's useful to know and makes sense regarding investments earning alot more than the interest payment on the mortgage especially if you can get a very low interest rate.

Everyone is different I suppose. I like to see the balance going down even if it is slowly.

[jamgy]

My mortgage rate for the last 5 years has been 1.4%, the S&P500 has returned an annualised ca. 12% over that time

I would have been far better off going IO and putting the difference in an S&P500 tracker - unfortunately I'm repayment there is obvious risk with that strategy

Also on a similar vein to the investment is the potential for using your pension to pay down the balance. If you've got say £200k left on the mortgage running til you can access a SIPP, and your SIPP is worth say £1m, you're likely better off putting the interest payments into the pension, get the higher return the underlying investments should generate, tax relief on top, then pay off the principal when the time comes with the TFLS

Chucking the figures in ChatGPT, with the above mortgage and SIPP values over the last 5 years of the mortgage term, with mortgage rate of 3.5% and investment return 8%, you'd be £24k better off putting the money in the SIPP

[LooneyTunes]

Josemartinez said:

Thanks all, that's useful to know and makes sense regarding investments earning alot more than the interest payment on the mortgage especially if you can get a very low interest rate.

Everyone is different I suppose. I like to see the balance going down even if it is slowly.

Suspect that not everyone calculates things properly as, to do a full analysis, you also need to take into account tax rather than just raw interest rates and returns. There’s no tax on the interest you avoid paying (when you make repayments) but can be with investment returns.

They can be quite popular with people working in low base/high bonus roles.

[FlyingPanda]

LooneyTunes said:

Suspect that not everyone calculates things properly as, to do a full analysis, you also need to take into account tax rather than just raw interest rates and returns. There s no tax on the interest you avoid paying (when you make repayments) but can be with investment returns.

£1,666 per month into a S&S ISA keeps you nicely tax free and has the added benefit of Dollar-Cost-Averaging your investments

[Hustle_]

FlyingPanda said:

£1,666 per month into a S&S ISA keeps you nicely tax free and has the added benefit of Dollar-Cost-Averaging your investments

Or indeed any amount up to £20k per tax year.

[FlyingPanda]

Hustle_ said:

Or indeed any amount up to £20k per tax year.

And 12 x £1,666 is?

[fat80b]

We have an IO mortgage.

For me it's about flexibility - The interest rate (with Santander in our case) is the same for an IO mortgage as it is for their repayment mortgage.

With the repayment mortgage, you are on the hook for the interest AND the repayment amount every month. With the IO mortgage, you are on the hook for the interest, and you can *choose whether to pay off the repayment portion / whether to do something else with it (ISA, pension, coke and hookers etc). i.e. the IO mortgage product is way more flexible.

Given the flexibility of IO vs repayment, I would ask - Why would anyone not go for the IO option?

[LooneyTunes]

FlyingPanda said:

LooneyTunes said:

Suspect that not everyone calculates things properly as, to do a full analysis, you also need to take into account tax rather than just raw interest rates and returns. There s no tax on the interest you avoid paying (when you make repayments) but can be with investment returns.

£1,666 per month into a S&S ISA keeps you nicely tax free and has the added benefit of Dollar-Cost-Averaging your investments

Which is fine, if that’s all you need to account for/don’t have other sources of investment income.

[chip*]

Josemartinez said:

Thanks all, that's useful to know and makes sense regarding investments earning alot more than the interest payment on the mortgage especially if you can get a very low interest rate.

Yeah, it helps a lot if you are certain there isn't a market crash just before the maturity of your IO mortgage too

[Hustle_]

FlyingPanda said:

Hustle_ said:

Or indeed any amount up to £20k per tax year.

And 12 x £1,666 is?

I know what 12 x £1,666 is, I am making one or more different points which have flown over your head.