Wealth warning: Interest-only mortgages are like power tools – useful in the right hands but capable of chopping them off. If you’re not sure you’ll stay interested in your finances for three decades, avoid! Get a repayment mortgage and keep life simple.
I have an interest-only mortgage. This confession causes some friends – and Monevator readers – to gasp.
Am I not a financial blogger? Don’t I know interest-only mortgages are risky? Weren’t they associated with the financial crisis?
“Are you nuts?”
I have my moments, but I’m mostly a responsible sort. And I believe interest-only mortgages are not as toxic as their off-ish odour suggests. In a couple of ways they’re arguably less risky than repayment mortgages.
Interest-only mortgages do have one big downside. We’ll get to that.
But they also have a couple of advantages.
What is an interest-only mortgage?
A quick refresher, and then on to the concerns.
- With an interest-only mortgage, your monthly debits to your bank only pay the interest due on your loan. You don’t repay any capital – and you needn’t until the end of the mortgage term. At that point the entire debt is due.
- This contrasts with a repayment mortgage, where you make capital repayments as well as interest payments each month. At the end of a repayment mortgage term – typically 25 years – it’s all paid off.
One obvious advantage of an interest-only mortgage is your monthly payments are lower, because you’re only paying interest, rather than capital and interest.
This may be appealing when house prices are high and interest rates are low.
Suppose you took out a £400,000 mortgage over 25 years at a ten-year fixed rate of 2.5%:
- Monthly payments with an interest-only mortgage: £834
- Monthly payments with a repayment mortgage: £1,795
Quite a difference! You’ve nearly £1,000 left in your pocket each month with the interest-only option.
Low rates make interest-only mortgages look like a winner. Here’s the same scenario with 1990s-style 12% interest rates:
- Monthly payments, interest-only: £3,999
- Monthly payments, repayment mortgage: £4,212
With very high interest rates, there’s is little difference between monthly interest-only or repayment payments. Either way most of your initial payments go on interest.
Today’s very low rate environment makes the interest-only option appear attractive when you’re only looking at monthly payments. Because rates are low, there’s little interest to be paid.1
Screamingly important: It’s not all about monthly payments!
These comparisons tell us about monthly payments – but not about the big picture of buying your home outright.
That’s because the interest-only mortgage is not being paid off.
In my example, with the interest-only mortgage there will be a £400,000 debt due at the end of the 25 years.
This gaping hole will need to be filled, either by selling your property to repay the mortgage – not usually a permitted as a plan for residential owners – or by using capital from elsewhere. (Aha!)
In contrast, the repayment mortgage will be paid off in full after 25 years. And long before then the debt will have dwindled significantly.
What’s more, the total amount you pay to own your home will be higher with an interest-only mortgage.
- As you pay down capital with your repayment mortgage, interest is charged on a shrinking outstanding balance, which reduces the future interest due.
- With an interest-only mortgage you pay interest on the full debt for the life of the mortgage.
I’ll get back to this in a moment.
The repayment mortgage as a piggy bank
We might think of a repayment mortgage as like a ‘forced’ savings account.
True, it’s a strange sort of savings account, because it starts with a massively negative balance – of minus £400,000 in my example – and eventually you ‘save’ back up to breakeven.
But it works the same way.
Every £1 you put into repaying off the outstanding capital increases your net worth by £1, compared to if you’d spent that £1 on sweets or beer, because you’ve now paid off £1 of debt.
If you started with a negative balance of £400,000, you now only owe minus £399,999.
You’re richer!
A repayment mortgage is often even better than a normal savings account, because you don’t pay tax on your ‘interest equivalent’ when reducing your mortgage, but you might pay tax on interest on cash savings. Depending on your total income and tax bracket2, this means repaying debt may deliver a higher return than earning interest on savings. (It’s all been made a bit more complicated by the introduction of the savings allowance though. Check out this primer from Martin Lewis if you want to do the sums.)
Of course the downside of this ‘mortgage pseudo-savings account’ is your home could be repossessed if you fail to make your payments. That’s several dozen shades darker than the worst that can happen with a real savings account.
Five perceived problems with interest-only mortgages
Let’s crack on! Let’s look at some arguments people make against interest-only mortgages, and why they aren’t necessarily a concern – and certainly don’t amount to a toxic product – in the right circumstances.
1. An interest-only mortgage is more expensive
This is one of the best arguments against using an interest-only mortgage – or perhaps I should say against misusing it.
Going back to the £400,000 mortgage charged at 2.5% for 25 years:
- The repayment mortgage costs a total of £538,4093
- The interest-only mortgage costs a total of £650,1134
The difference is in the interest bill. It is £111,704 higher with the interest-only mortgage. As I wrote earlier, that’s because you’re charged interest on the full £400,000 for the life of the interest-only mortgage.
Now you might be thinking you’ve spotted a gaping hole here in the logic of using an interest-only mortgage.
We’re trying to get richer around, right? Not poorer.
But as mathematician Carl Jacobi’s maxim states5 “Invert, always invert.”
With the interest-only mortgage in this example, you are effectively paying £111,704 in additional interest6 to rent £400,000 from the bank for 25 years.
After that, money that would have gone into repaying the mortgage can instead go into investments that will probably deliver a higher return overall.
Not a higher return than house price growth – that’s irrelevant here, see point #3 below – but a higher return than the 2.5% interest rate your bank is charging, adjusted for your personal tax situation.
That basically means global equities – shielded from taxes in an ISA or SIPP – which might be expected to deliver annual returns of around 7-8% a year, depending on who you ask and what period they look at. (Remember we can use nominal returns here, because your mortgage interest rate hurdle is also nominal. In real terms the value of your £400,000 debt is being shrunk over time, too.)
If you use an interest-only mortgage and invest, you’re effectively gearing up your portfolio with the mortgage debt. Every pound of debt that’s not repaid is effectively invested into your portfolio instead, for 1-25 years.
If all goes well, you’ll end up richer. After 25 years you’ll pay off your mortgage balance and the excess (we hope) is yours to keep.
Of course it’s not a slam dunk. Investing in equities – even with a lengthy 25-year time horizon – is much riskier than repaying a mortgage, which delivers a known return. There are no guarantees.
Also tax looms large. Compare an after-tax gain on equities with an effectively juiced-up after-tax return from paying down debt, and the potential differential shrinks.
For me this means that while I have headroom in my annual ISA and SIPP allowances, I’m planning to effectively run a larger, leveraged, tax-sheltered investment portfolio, rather than pay down my interest-only mortgage – at least for the next 10-15 years.
If I have spare cash after that (after an emergency fund and so on) I’ll throw it at the mortgage.
This is definitely a personal decision, and I guarantee people will turn up in the comments saying it’s too risky and you should just pay down your mortgage debt.
Notice though that these same people will often be paying into a pension while carrying a repayment mortgage – in some ways a similar proposition, though not one I’d personally argue against for a minute – or perhaps they had a defined benefit pension and were never faced with such decisions. (Certainly anyone who says using an interest-only mortgage while they themselves have a repayment mortgage at the same time as they’re saving into an ISA, let alone a general un-sheltered investment account, is riffing on their cognitive dissonance!)
Remember too that plenty of people have taken out interest-only mortgages without any plans to repay the debt. This is mostly why interest-only mortgages have a stinky reputation. But that is the opposite of what I’m suggesting here! I’m doing this entirely to grow my wealth, a portion of which should one day be used to pay off my outstanding mortgage.
Also note that you have some optionality with the interest-only approach.
My interest-only mortgage T&Cs allow me to repay up to 20% of the outstanding debt off in any particular year.
If markets do much better than I expect at any point over the 25-year term, then I can switch from investing more to repaying the interest-only mortgage before the debt becomes due, or maybe even deploy lump sums liquidated from my ISAs against the mortgage (though it’s hard for me to conceive of doing that and losing some of my precious ISA wrapper…)
Ditto if interest rates rise, and it becomes more expensive to run the interest-only mortgage.
Here’s a couple more articles to read on the topic:
- The dangers of borrowing to invest (Series covers several key points)
As so often, it’s make your own mind up stuff.
The Accumulator changed his mind in a similar-ish situation and decided to focus on reducing his mortgage debt rather than maximising his investing gains. No shame in that!
2. You’re not reducing the capital you’ll eventually owe
The second – also excellent – argument is that paying off, say, £400,000 is a massive slog for most of us, and you’d be best off starting early.
I agree that for many people this is wise advice.
However even with a repayment mortgage you might not be repaying much capital in the early years, depending on rates.
Sticking with my £400,000/2.5% example (and rounding for ease of reading) in the first year of a repayment mortgage you’d pay £9,860 in interest. You’d only pay off £11,666 of the outstanding capital.
So that’s roughly 45/55 interest to repayment.
The figures do get better over time. By year ten you’re repaying £14,610 a year in capital, with less than £7,000 going on interest. This is because your prior repayments have shrunk the debt that interest is due on.
But a big chunk of your early bills are actually going towards servicing interest, even with a repayment mortgage.
And it’s much worse when rates are ‘normal’.
At a more historically typical mortgage rate of 6%, you’d pay nearly £24,000 in interest in year one on that £400,000 loan, and merely £7,000 of the capital.
That doesn’t seem so much a repayment mortgage as a mostly-interest-mortgage!
Here’s an illustration of the interest/capital split under a 6% regime. Notice how long it takes for capital repayments to outweigh interest payments:
With a 6% interest rate, even a repayment mortgage is mostly paying interest early on.
Of course we don’t currently live in a 6% regime. You could argue that with today’s low rates it’s actually a great time to have a repayment mortgage and to slash your long-term debt, exactly because most of your payments are going on capital.
It’s a coherent argument.
My point is simply that both interest-only and repayment mortgages feature a lot of interest-paying, at least initially.
It’s just a bit disguised, because when a bank rents you money to buy a house, it all gets wrapped up in one monthly bill.
3. You’re not smoothing out your housing exposure
This argument is wrong thinking, but I’ve heard enough people say it that I suspect it’s pretty common.
The (faulty) logic goes:
With a repayment mortgage, you’re gradually increasing your exposure to property as you pay down your debt.
Often they will add something like:
“The stock market looks wobbly, so instead of investing I’m going to make some extra payments towards my mortgage in order to put more into the property market instead. You can’t go wrong with houses!”
I’ve even had a friend suggest to me that repaying his mortgage over time (including with over-payments) is like pound-cost averaging into the stock market.
But while this certainly results in good financial discipline, the theory itself is nonsense.
When you buy a property is when you get your ‘exposure’ to the housing market. Your exposure going forward is the property you bought. The cost of that asset is the price you paid when you bought it.
Everything else is financing.
Most of us take out a mortgage to buy our home. How we choose to pay that off – every month for the life of the mortgage or in one lump sum in 25 years, or something in-between – is about managing debt, not altering our property exposure.
If you make an extra £50,000 repayment towards your mortgage, you haven’t got £50,000 more exposure to the housing market. Your property exposure is still whatever your house is worth.
Rather, you’ve paid off some debt (/done some enforced saving!)
True, it’s debt that is bucketed against the specific asset of your home. But that’s it.
The way to pound-cost average into the residential property market is to buy multiple properties over time, or to invest in a loft extension or similar.7
4. What if you can’t make the interest payments – you won’t own your home?
People seem to believe using an interest-only mortgage is more precarious than a repayment mortgage. You often see this insinuated in articles.
There is a feeling that somebody living in a home financed with a mortgage where they’re not paying down debt each month is living on a limb.
But your financial situation is more than just your house and your debt.
It includes your cash savings, your investments, your pension, your monthly income, your liabilities, and more.
When I bought my flat with an interest-only mortgage, I put down a 25% deposit. Since then I’ve repaid almost no capital8.
In contrast, my friend P. bought a flat around the same time as me with a 20% deposit and a repayment mortgage. He will have since repaid a couple of percent of his mortgage.
I don’t see that he’s in a more secure position than me, on these bald facts alone.
- Neither of us own our properties outright.
- Both of us could be repossessed if we fail to make our mortgage payments.
- He’s made bigger monthly payments to his bank. I’ve put a higher percentage of my net income into investments.
You could even argue that my interest-only mortgage is less risky, on a month-to-month basis. My monthly payments are lower, and so they would be easier to meet in a pinch. The rest of the time I can – and am – diverting the spare cash into building up my other savings and investments, not spending it.
This actually gives me more of an accessible ‘liquid’ buffer than he has.
With an interest-only mortgage you can also spread your assets more widely than someone who is putting everything into paying down their repayment mortgage ASAP.
Their assets may be very over-weighted towards one single residential property. More of yours will be in global shares and bonds (effectively financed by your mortgage…) in addition to property .
Of course, if you just use your lower interest-only payments to live beyond your means rather than building up your investments then it’s a different story. I’m not arguing for paying lower monthly bills and then moaning to the regulator in 25 years that you didn’t understand you had a debt to repay!
But blame the player in that case, not the game.
5. You don’t ‘really’ own your home, even if you do keep up the payments
My mum said this to me. She seems to believe she always owned her home because she was paying off her mortgage each month, whereas because I’m not she thinks I don’t own mine.
This is all hand-waving stuff.
Some people say the same about homes bought with repayment mortgages, too. They say the bank ‘really’ owns your house. That you’re just renting until you’ve paid off the mortgage. Until then you’re a tenant of the bank, which is the ‘true’ owner.
This is wrong, legally speaking.
When you buy a house you take legal ownership of that property9. It’s registered under your name at the Land Registry, and you have various rights and responsibilities that come with ownership.
If you happen to buy it with a mortgage, then you’ve also taken on commitments to the bank that lent you the money.
Because some people don’t repay their debts, banks want some security.
And… you’ve just bought a home… so hey, there’s a big lump of hard-to-move security sitting right there!
Invariably then, when a bank lends you money to buy a property, this loan is secured against that same property. That’s why the bank gets your property valued beforehand. (You didn’t think it was for your benefit, did you?)
There are all kinds of implications from using a mortgage like this, but not owning your home isn’t one of them.
Of course with an interest-only mortgage you do need to repay the debt eventually to stay in your home. Your 25 years of home ownership will come to an end if you have to sell your home to pay off your mortgage.
That’s 100% true.
But it’s not a reason to avoid an interest-only mortgage – it’s a reason to have a plan.
Outstaying your interest
There’s a vogue on this site at the moment to crunch numbers, but at 3,000 words I think this article is weighty enough.
Boiling it down, it’s a pretty simple concept…
Investment returns > extra interest-only mortgage costs = win
Investment returns < extra interest-only mortgage costs = loss
… maybe adjusting your investment returns by a risk factor to reflect the uncertainty of gaining them.
I’ll say it again, to try one last time to stop someone in the comments saying I said something else – for most people, a repayment mortgage is a simple, reliable way to buy a home. It will probably reduce your financial vulnerability over time. It should be the default choice.
But for those of us who like to juggle our finances for fun and profit, an interest-only mortgage is well worth considering.
- Then again, high rates usually come with high inflation, and that would be eroding the real value of your debt quicker. [↩]
- And the interaction with your personal savings allowance. [↩]
- Mortgage debt of £400,000 and interest of £138,409 [↩]
- Mortgage debt of £400,000 and interest £250,113 [↩]
- via Charlie Munger. [↩]
- Of £250,113 in total interest. [↩]
- Or to buy shares in one of the few listed companies that owns substantial amounts of residential property, such as Mountview Estates. [↩]
- I made one small ad hoc payment to ensure it worked. [↩]
- Well, assuming you own the freehold. It’s more complicated with a leasehold property, but let’s save that for another day. [↩]
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Great article. One thing you maybe should have mentioned, is that, as far as I can tell, interest only mortgages are more expensive in the sense that the interest rate is actually higher.
E.g. I see 2% for repayment, and 2.6% for interest only, say.
Disclosure: I have an enormous 30 year interest only offset mortgage, and I absolutely love the flexibility it provides!
The opportunity cost of buying our place outright was something I thought a lot about. But having lived through the high interest rate times of the latter part of the last century and seen how easily people could spiral down after job loss – I thought I’d sleep better at night by simply biting the bullet. As it turned out, the timing (2012) was good – the rent I was paying went into my pension where it benefitted from the boom of the last decade and salary increases/self employment meant I rebuilt my cash savings fairly quickly too.
I’ve come around to the idea that an IO mortgage is the way to go for FI as part of a larger plan.
I’m 38 now and our mortgage is about £140k with about 20 years to go – not as much as some I’m sure – but if I think about early retirement, I still need to pay off about £6,000 a year.
Go IO, invest £8k a year (or don’t earn it) and cash in the TFLS of 25% of SIPP at 58 and it’ll be paid off!
The difference is HUGE, so why delay, remortgage today!
So here’s the rub – where do I get the IO mortgage fixed for 20 years when I have intentions to jack it all in?
Just to say – a quick check online shows bargain basement 5 year / 7 year / 10 year IO mortgages.
Just need to pass the eligibility checks first. 🙂
@Finumus – yeah, off-set mortgages rock. Ours is repayment and we’ve 95% covered the capital and repayments come out of the off-set account. Provides a hefty emergency fund too! For me, I’d rather the security of forced savings. Especially with a young family. We effectively paid off our not unsubstantial mortgage in 5 years. Yes, I have an opportunity cost in missed growth in investments. But boy, does it feel good and I sleep like an angel!
I also wonder if this article also suffers from Recency bias? Rock bottom interest rates, soaring property and equity values, super-low volatility…
Btw, did I mention how well I sleep?
I think the general preference for repayment over interest-only mortgages is essentially behavioural rather than financial. People who have well laid savings plans like The Accumulator are very much in the minority. Too many people with interest-only mortgages have left it as a problem to be looked at nearer the redemption date – when they find themselves in a hole.
But I agree with others that an offset arrangement, whether from interest-only or repayment mortgages, is great. You are effectively getting interest on cash savings at a higher rate than otherwise available, and without having to worry about tax.
I don’t see anything to be scared of. I’ve had three mortgages in my life. All have been American or multi-european callable IO offsets. They offer total flexibility so I wouldn’t consider anything else. These days the typical spread over the vanilla amortizer is very tight. I don’t have a mortgage simply because in terms of having a standby flexible credit line, a margin loan is even cheaper but clearly you have the MTM risk on that which could create other possible issues.
The vast majority of debt products such as government and corporate bonds are IO products and nobody is scared of those. Amortizers are more the exception than the rule.
It is a simple opportunity cost decision.
If you can use the borrowed funds to achieve a total return greater than the financing costs, you win. Interest only debt is just one of many tools at our disposal. Beneficial when used correctly. Capable of great harm when used inappropriately.
For example, VHYL currently has a dividend yield of 3.22%. Interest only term offset mortgages can currently be had for 2.13%. In this contrived case the gross investment income covers the borrowing costs, so the investment effectively finances itself. Usual caveats that the example ignores taxes, and that chasing high yields often turns out to be an own goal from a total returns perspective.
Of course rates will rise, yields may fall, and personal circumstances may change. Buyer beware.
Like a lot of things in life, leverage (howsoever structured) works until it stops working.
As long as you understand the risks before hand, then so be it – i.e. forearmed is forewarned.
Ern has an interesting take on using mortgages and how they interact with sequence of returns – see https://earlyretirementnow.com/2017/10/11/the-ultimate-guide-to-safe-withdrawal-rates-part-21-mortgage-in-retirement/
In particular, his conclusion that “The comparison “expected equity return > mortgage rate” is just too simplistic” deserves some thought. My own interpretation of this is that, on average it will probably work out ok, but not for all cases. Which should sound very familiar to anybody interested in, so-called, safe withdrawal rates.
Personally, I paid off my main mortgage as quickly as I could and believe that achieving that milestone actually had a transformative impact.
You say that you cannot sell the property to repay the mortgage. That was not my experience. I used an interest only loan to buy a property that I would not have been able to afford with a repayment mortgage. I used the reduced monthly outgoings to provide a reasonable standard of living while the kids were still around. In the interim, the value of the house had appreciated due to price inflation. When I got near to retirement, I sold the property, downsized and repaid the mortgage and am now mortgage free.
12 years ago I sold my business and with the funds paid off an IO offset mortgage of around £100,000. In hindsight this was not a good move as now have a nice house but very little income so will have to either downsize for the second time or go down the Equity Release route. I could have put that £100k in a Tracker Fund and had a reasonable return and continued to pay the interest only.
I’ve been thinking of possibly of getting an Equity Release type offering now the rates are dropping and investing this for the long term in a Tracker Fund in anticipation I might be around for another 20-25 years. I’m currently a very ft and healthy 72 years old. Any thoughts?
This is an excellent article. We are looking to buy a new main residence and are likely to go for an fixed 10yr IO for the same reasons. We will max out our tax deferred accounts which will eventually be used to pay down the mortgage. Not only will our investment return very probably be higher than the mortgage rate but we will effectively be able to pay from gross income too: massive advantages that significantly move the needle.
@Gizzard: Hi! You write:
I didn’t say that. 🙂 In fact I specifically say that if you don’t have any other way to repay the mortgage then you will *have* to sell your property to repay the mortgage.
What I said was it is not accepted as a repayment *plan* by the banks lending you the money. More than one bank I spoke to told me this.
Perhaps in the past you were able to state you’d sell your property as your repayment strategy, but today as I understand it you need to show evidence of a plan that involves generating the capital elsewhere. 🙂
@Dave Tester AirBnB, take in a lodger, rent your driveway out if any of those are applicable?
Wish we had gotten an IO mortgage when we were living in Surrey when house prices briefly dropped in 2009. Too late smart!
Have only ever had IO mortgages over my 21 yrs of home-ownership (started off at the tail-end of the endowment mortgage fiasco.)
Took out my current mortgage in May ’08 at the height of the GFC. It tracks base rate +0.75% for the life of the mortgage, allows unlimited overpayments, came with drawdown facility which I’ve never used, and had no arrangement fee at all (the latter quite unusual, even at the time.)
Obviously back then I had no way of knowing where interest rates were going to go, but it couldn’t really have turned out much better.
As an aside, I now have sufficient funds to clear the mortgage if required.
Don’t forget that inflation will also be eating away at the debt relative to your earning potential. I remember someone saying in the 80s you bought as much house as you could, as in a few years the huge debt was basically a fraction due to high wage growth. In todays world this is less true, but over 25 years….
Maybe it is just me, but I am a bit confused as to who wrote the article because:
a) it says @TA at the top;
b) then later on (just above point 2.) it says “@TA changed his mind ….” , and finally
c) at comment #13, @TI answers as “I didn’t say that …”
Apologies in advance if this is just senior moments from me!
@Al Cam — No, it’s me who is having the senior moment! Sorry for the confusion.
It was set to @TA by error during subbing… I’ve now changed it back!
Thanks very much for the heads up.
I had a flexible Offset interest-only mortgage that allowed unlimited overpayments for a good many years, that I made hefty monthly repayments on. As a contractor at the time it made a lot of sense, and allowed you to borrow back for emergencies or opportunities just by transferring online from your mortgage account to your linked offset current account. It meant you didn’t need to have a huge pile of emergency cash.
More recently the interest rates for such flexible products have climbed further over normal repayment mortgages – an increased risk premium perhaps? Looking at other offset mortgages from other providers I found they were not flexible, in that you couldn’t borrow back once you had made a repayment.
Anyway the interest rate premium for offsets no longer seemed to stack up, so I just moved to a conventional 5 year fixed rate repayment mortgage for the longest possible term (beyond which I actually intend to clear the mortgage) to get a crazy low rate of about 1.5%. This keeps monthly payments as low as possible, but still pays down some capital and builds equity. This way any reduction in income will be easier to manage should hard times come.
I’m no longer worried too much about making regular overpayments as I go along, as I intend to make up ground either at remortgage time or using the 25% PCLS.
Committing to high monthlies to achieve some self-set mortgage goal is just too risky if you have any mishaps along the way. It was OK with my previous flexible offset, but not with a conventional mortgage where you could face arrears if you get behind.
The loss of the ability to borrow back does mean there is a need to increase cash savings, so will be topping up the emergency fund.
Ive read of people using an offset mortgage, and using slow stoozing from 0% purchase credit cards to effectively move the debt onto a card, not secured against the house, and only paying interest/a fee if you use a balance transfer card, although you would be maying minimum payments on the card, and you can borrow far less on cards than mortgage, so watch affordability
You can think of repayment mortgages like a bond purchase, albeit not fixed income since the interest rate can change, and that said your return upon a mortgage overpayment could increase if rates went up
Good for you TI.
I took out one of the first PEP (‘Personal Equity Plan’ for those too young to remember) Mortgages back in the day to buy my first house and did very well out of it.
If you’ve the discipline and a logical belief that equities will rise over time then I’m not sure why you’d choose any other option…
I haven’t purchased a house yet and might look to do so in the future if my circumstances change. From what I can see online there seems to be a lot of articles that suggest that it is far harder to get an interest-only mortgage than a repayment mortgage. Can anyone anecdotally confirm or deny this?
Also at present, the area that I live in has some low-cost houses (or at least what I consider to be low-cost sub 100k) this is what I’d presumably look to purchase. I hold a LISA account, which means I am obliged to take out a mortgage when I purchase a house. Am I correct in thinking that this essentially caps my LISA to the property value less the smallest possible mortgage value? (Quick search seemed to suggest 5k was smallest)
So as a worked example, if I wanted to buy a 50k house, with a 5k mortgage the most I could have in my LISA would be 45k? I only ask as I’m considering paying into a Stocks and Shares LISA as I do not intend to purchase a property any time soon. I appreciate that if this was the case, and I had say 46k in my LISA, I could carry the remaining 1k over (?) but I’d rather not overpay into a LISA for reasons previously highlighted onsite.
I believe theres a balance to be struck – and if youre going to buy some amount of quality debt when you invest, why not make it the debt thats secured against your house?
It will depend on your tax situation too, and for UC claimants being able to reduce your monthly payment via overpayments is potentially a more immediate reward than a pension would be (if they needed to dispose of cash for means testing), thus safer, more liquid than pension
Given that property counts towards your IHT allowance, I am toying with the idea of selling up and using the proceeds as income (to pay my rent).
Or for all the mental mathmos out there, how’s this for an idea…
https://www.ft.com/content/d645649e-eb6e-11e9-a240-3b065ef5fc55
Do you hold any bonds in your investment accounts? A 1.5+% interest mortgage invested 0.57% 10 year gilts is not a moneymaking proposition.
@GFF (3) “…cash in the TFLS of 25% of SIPP at 58 and it’ll be paid off!”
Assuming, of course, that in 20 years time:-
1. You can access the TFLS at 58, and not 62 or 67 or whatever.
2. You are still allowed to access a TFLS.
3. SIPPs still exist.
Under any of these scenarios you’ll be in a ‘difficult’ situation, and without a proverbial paddle.
@The Borderer
Tax/pension rules might change between now and 2040 – in fact they might have changed by this time next month!
However, the hardest thing about an IO mortgage is getting one right now – maybe it’s getting easier.
I’m 2 years through a 5 year fix – will probably be FI by the end but the complexity of paying the mortgage bumps up my FI requirements massively to the point of penury!
Is it worth switching now? Maybe yes maybe no. But at least I think that I can handle the risks of 1) spending too much 2) poor investment returns 3) changes to tax/pensions – most people won’t be.
One of the pitfalls of IO mortgages is (from headlines in the press) that people just spent the difference and are at the age of 60+ being asked to repay or be thrown out of their* home! Think of the homeowners!!!
So, lifetime interest only mortgages (or equity release or whatever) will be the way to go for many. Never own outright and pay the minimum or roll it all up into a neat debt egg to pass on to your love ones.
*rented from the bank for the past 25 years with any equity MEWed up the wall – equity is just dead money afterall.
I wonder if people can switch from interest only straight into equity release…
What price certainty?
A repayment mortgage with an overpayment buffer means that I sleep easy at night.
Of course, I could convert to interest only and invest the difference, but like many here, I’m already well and truly exposed to the vaguaries of the stock market.
For me, a happy compromise is a repayment mortgage and a slightly riskier investment profile than I might otherwise tolerate.
It seems a very clever idea. Bit too clever for me perhaps.
@GFF – you identify 3 risks”d “1) spending too much 2) poor investment returns 3) changes to tax/pensions”. I’d like to point out that only 1 of those are in your control. Is there a danger that after a decade long boom, people (generally, not aimed at anyone in particular) are getting over-confident? Thinking this is the “new norm”?
I’m just glad I went repayment. Nice and easy. Did I mention how well I sleep? 🙂
@ Brod – everyone’s situation is different and attitude to risk too!
As it stands the mortgage interest we pay each month is about the same as council tax. That’s something that will not go away no matter what you do!
So – there’s always things that could keep you up at night.
I still think that over a 20 year time period I could invest better than my mortgage costs and if you add in tax efficiency into the mix – the IO mortgage is the way to go.
Without putting anyone on the hook for “financial advice”, other than IO mortgage what are the alternatives to securing a mortgage against your S&S ISA? The original TI article regarding how the mortgage was acquired was quite timely given that I’m in a similar situation albeit not currently holding enough savings to effectively buy a property outright. As you can imagine though I’m loathe to liquidate ALL my savings to front a deposit. Also offset, as I understand it, would require me to essentially hand over the cash for someone else to manage anyway. At this stage my mortgage enquires are purely exploratory. I might not decide to buy at all and leave the UK for sunnier skies.
@GFF – fair enough. If that suits you, horses for courses.
Interest Only mortgages can work out well if used correctly and a preference for a repayment loan is likely to be a behavioural decision rather than financial.
Used an I/O twice, it assisted cash flow on one occasion, on the other a period of poor equity returns made the positive outcome very marginal. ( equities can give poor returns over extended periods…)
I have seen friends use I/O as a means to increase spending and it has worked out very badly when they retire…..
I’d suspect that this websites readership is a financially competent subset of the general population!!!
@Dave Tester #11
I have a relatively small, equity release, lifetime mortgage to fund the future-proofing of my property. This mortgage was arranged under the auspices of a well known older person orientated insurance company, via a retained financial adviser firm which carried out a thorough fact-find.
During the course of this fact-find, and merely as thinking aloud, I asked the adviser who had been allocated to me, “Ostensibly borrowing to improve my property, what would stop me from actually using the money to invest for income/capital growth instead?”. He replied, “That would be mortgage fraud!”.
It was only a thought on my part, and I left it at that, but you might want to check the situation out for yourself.
I went IO in 2011 and put the money saved into my pension, thus saving 42% ish tax. Plan is to use some of the lump sum to pay off the capital of the mortgage, thus in effect it will have cost me a little over half to pay off the mortgage compare to if I had a repayment mortgage and payed it off using after tax income. Anyone who is a higher rate taxpayer and not using up their full annual pension allowance whilst servicing a repayment mortgage is missing a BIG trick. Doing it this way massively decreased my time to FIRE.
Also, I can’t see Interest Rates rising significantly as it would bankrupt the country (both the government and mortgage holders who are now massively leveraged up), could be wrong, but if I am there will be many many people hitting the food banks before I need to, so I would image IRs would be lowered again or rampant inflation would effectively pay off the capital.
@Dave Tester #11
Re-reading your post, I don’t think you were necessarily contemplating borrowing to invest but hopefully my warning is still useful here.
I’m happy for anyone to use interest only mortgages if they make sense for them, but there are a couple of things that I think are relevant that aren’t in your analysis.
Interest rate: We couldn’t find IO mortgages with rates as low as repayment. We’re currently on 1.51% for 2 years with 15% deposit. On a £400k mortgage that would mean we have £40k less tied up in deposit and will post around £4K per annum less interest than the example (obviously the fix length is very different).
In two years when we remortgage we can either take equity back out off the property or pay off more based on our preference at the time.
Recently had an IO mortgage at 1.2% 2 year deal. £600pm, lovely. However knowing if, for whatever reason (2008, Northern Rock etc?), a new deal was not forthcoming and the mortgage reverted to 4.5%, £2250pm IO was a bit terrifying. Have since downsized to be mortgage free. Which is just to say that the obvious danger with IO is it allows you to chase up what you think you can afford… and when everyone else does the same…. we all know where this could go!
Quite surprised at this article on the usually excellent monevator and the seemingly relaxed approach to capital repayment risk and the loss of a home.
The mortgage endowment policy mis-selling and significant shortfalls of the 90s are a very recent example of the dangers and problems of this type of interest only / investment strategy. Investors likely already have significant life & wealth exposure to the equity market in terms of their pensions and saving investments, adding to this further with capital needed to repay a home mortgage would appear an unnecessarily greedy roll of the dice. Should (when?!) equities crash, being faced with material reductions in pension, savings and then combining this with a shortfall in the ability to repay your home loan & risk of being turfed out and having to find new accomodation would to me seem an unwise risk.
Still gamblers often have a tendency to think it won’t happen to them, “this time next year rodders”. Good luck to you whatever choices you make!
It doesnt have to be either or. You can mess with the mix over the lifetime of the mortgage too. You can choose to increase overpayments and or investments as you see fit. The offset idea looks like the most flexible option. You can overpay as much as you like and still get access to the cash when needed. Start off putting your 6 months emergency fund in.
Investments normally provide an income, you could choose to use some of this to start “overpaying” and adjust over time. Nothing for years 1-5, compounding investments and then start to put say 10% of your investment income in years 5-10. why not 30% or 50% after that, there are so many options.
Most people get pay rises, promotions etc so can add more to both overpayments and investments as time goes on anyway. The offset also allows for savings such as car new kitchen etc to reduce interest whilst you save up.
On paper, the IO option seems the logical way bearing in mind that over a 30 year period you are almost guaranteed to make on the market. I suppose it comes down to the exit point and timing. Markets on a high when you have to sell up great but if you have just suffered a big market fall just prior to having to stump up it will be quite difficult, even knowing that most likely you would get it all back in a few years.
Still most people are likely, if used sensibly to reduce exposure over time as the repayment cliff edge approaches via the various options mentioned even though it is likely to be later in the life of the mortgage and or when it becomes more expensive.
If the investments do average over time then costs of the mortgage might be much cheaper, you only need £200k of investments @ 5% income to cover £400K of 2.5% mortgage. As you need to find this £400k at some point it looks like the investment route looks best for now and if the situation changes, well so can you. The flexibility is the key.
Still I would knock those who feel that a repayment makes them sleep better. Although I know someone who overpaid his mortgage and put as much as he could into his pension but came unstuck when he lost his job and had no cash or investments available and eventually lost his house. His pension pot was worth nearly a million! but couldn’t access it.
I’ve taken a slightly different approach with my mortgage for the reason @Mr. Zarnewoop mentioned.
I took a repayment mortgage with a short term to increase the payments and then made additional 10% lump sum payments per year. Once I felt the debt was manageable I extended the term for as long as I could and saved the difference plus the lump sum payments into a Shares ISA.
I’m now in the luxury position of being able to pay the monthly payment from what I’ve saved if I had to in an emergency. When my fixed deal comes to an end I’ll be going interest only and saving the difference in my pension. I may also put some of the growth in my ISA into my pension.
I can sleep at night knowing that I can pay my mortgage until I get hold of my pension lump sum, while being able to take the approach The Investor has covered in the article.
There’s quite an interesting use of flexible ISAs and Offset mortgages, where you basically get to use the offset mortgage to keep rolling over your ISA allowances, by borrowing increasingly large amounts of money for the few days round the end of the tax year.
This enables you to pay down your mortgage quickly, but sort of hedge the risk of ending up richer than your thought, and being able to use all those ISA allowances later in life. Slight plug – as detailed here: https://www.finumus.com/blog/how-to-get-an-80000-annual-isa-allowance
Very well written article.
Only thing I would add is if going the interest only route and cohabiting the insurance to pay off the mortgage should one of you die will be more expensive as the capital isn’t reducing. Just another factor to factor in. Insurance for repayment mortgages is normally reduced due to this. It’s not enought to counteract the advantages of investments, but it’s something you should think about should you choose this type of vehicle.
In a way (and #TI will hate me for saying it) expunging the benefits of an Interest Only mortgage if you invest is kind of like filling the whole that the Ye Olde Endowments had but without the massive fees! 🙂
Countless people have ruined their lives taking unnecessary risks. A $400K time bomb hanging out there in the future, that’s kinda scary unless you are making several hundred thousand a year. I have no debt of any kind, haven’t had in many years. It’s a nice feeling, but one you’ve eliminated as a personal option. The problem with this kind of financial risk is you only get to fail one time, then it’s game over. The math says it’s like a 99% winning strategy, no doubt, but I’m never getting on a plane with a one percent chance of crashing.
Like others, we (yes most of us do have spouses with whom we share our assets and liabilities…which is what I assumed “for richer for poorer” really meant) have an IO offset mortgage which has been fantastic. Now largely repaid it sits there as a committed line of credit available in emergencies or indeed to be deployed in event of a market crash.
One flavour of IO and the benefit that hasn’t been greatly discussed is the R(retirement)IO mortgage. This seems to me to be a potentially great IHT tool and I am thinking about getting one once my offset expires. If your estate is skewed to the value of your primary residence, likely to exceed the IHT threshold and you don’t want to move you can take out a RIO for the excess and distribute / spend the proceeds (or drip them into AIM ISAs) and save the IHT.
No more dangerous than renting, at least with an i/o mortgage youll probably gain equity with house value, and if worst comes to the worst and you have to sell, youre no worse off than the legions of renters
Like all things, i think a mortgage should be well endowed
@Matthew – no worse off? I mean, really? You’ve never heard of house prices going down? How old are you?
@brod – over a multi decade period? Nope, over several years, sure. Of course they could in theory still be down over the long term (v unlikely) and even then the i/o mortgagee has had years of not paying a landlord’s return, a landlords tax, or estate agent fees, landlord insurance, etc – so in the long term its almost inconceivable that the mortgagee has had a worse ride financially than a tennant
Someone upsizing might be somewhere a shorter time, but if house prices go down then overall the value gap usually closes between them and what they want to buy, whereas someone who’s downsizing has probably reaped years of savings.see
Point is in all probability its hard to see how youd be worse off than a renter with an i/o and youd probably have to be in some pretty niche scenarios, like downsizing only a few years after getting on the ladder, even then combined with terrible timing
My personal thoughts. It’s better I think to have a cheaper house and a plan to pay off as soon as possible. Whichever way you dress it up,you are buying debt. The bank owns your house till its paid off. Only a freehold mortgage-free house is owned by you. There is no easy answer as we need places to live. But I think best to structure finances in such a way to pay debt asap.
@gerry, surely the point is, that if your friend had actually paid off his mortgage, there would be no risk of losing his home when he lost his job.
In any event, it seems he may not have paid attention to the basics of personal finance, in his rush to maximise tax relief on pensions. Those are – 1. have a cash emergency fund to cover expenses for at least 3-6 months, in case of loss of income (sickness or redundancy). 2. Insure against catastrophe (ie, if you can’t pay for your housing if you lose your income, insure against loss of income).
I think the general problem is that human beings tend to assume that the future will be like the near past. If all you’ve known is house prices going up, interest rates being very low, and equities going up, and being in well paid work, then you tend to think that’s how things will continue.
I personally think, if your home matters to you, don’t gamble it.
@adam – although we only have a lease on life itself! One day merely staying in this world will be too difficult for us, and before that even we might be in nursing homes…
@vanguardfan – its possible that a pension used to pay off a mortgage is the quickest, and therefore (further down the line) safest route, and being cautious in the short term can cost some safety in the longer term. Really its all about shifting risk around between the present and the future, theres no right or wrong answer, but I bet the great unwashed population generally doesnt have 6 months emergency cash, so in order to sink us (with our investments too) you’d need something pretty cataclysmic where either the world or us personally would have bigger problems to think about
@matthew I was commenting on Gerrys friend’s scenario. Pension savings are no help at all if you can’t pay your mortgage and you are 40. I agree, it is certainly not possible to avoid all risk, but there are surely some quite sensible fundamentals that shouldn’t be forgotten. One of those is to go through a mental exercise as to how you would survive financially if your income disappeared for several months, for example through illness.
@vanguardfan – for some it should be feesible to survive off universal credit, which is a basic income insurance, low earners would not lose much and fire savers should be able to survive too, in a real pinch I believe you can withdraw pension money early with a 55%(?) penalty (obviously not ideal but weigh against opportunity cost) – and if universal credit doesnt cover the mortgage perhaps sell up and perhaps even rent – again not ideal but one would survive
It may be easier too for low paid to get back into similar work, if they are determined
Caution is good though if it helps people sleep at night, although i think people do overworry or not realise there are worse off people who survive…
For the low paid I recommend to isa their personal savings and uplift to sipp later, it doesnt make a mathematical difference to apply the tax uplift later
@matthew just to correct the factual inaccuracies. It is NOT possible, in general, to withdraw from your pension early. At all. It’s not a matter of simply paying a penalty. (Except in some cases of serious ill health and some other small print exceptions).
And, there is very little support for mortgage holders within universal credit. Nothing for the first 9 months, then a loan for some of the mortgage interest.
Awesome – a tour de force on a topic I’d never even considered; even though I paid my mortgage off a while back. Great work @TI !!
Interesting article I’m considering doing just this. 275 k mortgage 55% ltv 107k isa and 250k pension at age 39 really toying with the idea of going io
@Mattthew – you state, vis a vis house prices going down that yes it could happen in the short term. Well, how about 10 or 11 years? That’s how long it took house prices to nominally recover after the 1989 crash. That’s OK on it’s own, save for those trapped in a house they don’t want to be in and constantly worrying about the debt which isn’t reduced, but most house price slumps are caused by/correlated with something else – recessions and unemployment. If you lose your job, you’re in trouble.
I’ve got a feeling that your only experience of stock market crashes is 2008/9. This was very atypical. Most crashes combine with mass job losses, rising house repossessions and last a long, long time.
Personally I am not sure it is worth the risk. There is one scenario where it does make sense – where you have a large mortgage and repayment will eat up a large amount of you disposable. In this case the risk of losing your job and having unmanageable payments plus the risk of not being able to save a decent amount for the future both make the argument stronger vs the risk. Where repayment is a fairly low percentage of disposable, so you can save plenty anyway and don’t have such pressure if you lose your job, I don’t know why you would take the risk. And ideally most people are in the latter group (appreaciate realisitcally most are probably in the former).
If you could get a loan for similar rates, would you borrow to invest? Of course it is more risky as no underlying asset, but that asset may not be worth what you need at the time things go belly up as others have alluded to (of course it is unlikely the asset would be worthless, so slightly less risk). Too rich for my timid blood
Read this earlier today and thought it might add something to this discussion
https://www.thetimes.co.uk/edition/money/why-not-try-a-taste-of-picknmix-mortgages-8lq2swkht
Before reading this Times article I did not know that such mortgage flexibility existed – at least in principle.
Earlier in life I did use what was then called a “part and part [as it happens, repayment] mortgage” – but that only extended to part being fully flexible, and part being fixed rate – to hedge my bets.
It only makes sense if you expect relativly good house value appreciation with time and somewhat lower interest rate. I would say higher than X * inflation and Y* you_interest_rate (X and Y are to be calculated, plus tax rate). The same as if you borrowed money to buy an asset and want to realize capital gains after some time. Plus you are getting additianl benefits of housing minus costs depreciation.
This all can be calculated plus you can use swap rates to see what the market predicted interest would be in 20 year.
I would like to see those calculations with real numbers rather than emotional “common” sense story…
Could you outline the cases for (with all assumptions):
– typical mortage
– interest only
– rent and reinvestment into market (7.5% avarage)
Why 42%? Where did you get the 2%? NICs is still payable on all pension contributions other than employer ones.
I don’t really like any sort of long term debt, it’s a potentially unquantifiable liability.
This tends me towards getting shot as soon as possible.
The issues. How do I know what interest rates will do in the future? What if house prices fall and my equity becomes negative? Will I be able to re-mortgage? Will I be subject to high interest rates, I might struggle to pay? These are things I can’t control and lack of control has the potential to turn into sleep deprivation if any of these outliers actually comes to pass..
The solution for me was the offset mortgage. It was a game changer and more people should use them (IMHO).
Advantages
Every penny I have saves me mortgage interest, even “hot” money that flies in and out (salary for example).
I can over pay whenever I want (though you can just leave the cash in the bank and achieve much the same effect)
I can structure it to pay the minimum (which I now do and every month a small capital repayment happens)
It ends massively reducing the interest paid (I’ve paid very little interest over the last 20 years). Clearly that has some opportunity cost, could I have invested the money for a better return?
Disadvantages?
Rates tend to be a touch higher, but I’ve stayed the standard variable rate and ensured a larger and larger portion of it was offset, to counter.
The 85K protection could be a problem. The mortgage and savings are looked at seperately. So if the bank went bust and you had a 400K mortgage offset by 200K, you’d still have have a 400K mortgage and get 85K back. Hence to mitigate this small risk periodically “really” pay some of it off.
In the end I believe in balance, yes equity wealth should be increased, but also debts should be reduced. I paid one house off and am fully offset in the current one and could pay it off tomorrow, albeit by losing flexibility.
My risk profile is now very much lower and it was made possible by the offset mortgage.
@Brod #59
> Well, how about 10 or 11 years? That’s how long it took house prices to nominally recover after the 1989 crash.
I was that guy. Buying a house in 1989 is still the single worst personal finance mistake of my entire life.
Compared to that churning dotcom ‘investments’ and then quitting the market at the low-water point of about 2003 pales into insignificance. At least I got a valuable education whereas the house purchase still makes me want to get in a time machine and throttle my younger self or at least slap him around the chops with a wet fish. It wasn’t as if people didn’t suggest that Lawson’s meddling wasn’t inflating house prices.
Which highlights the other dreadful problem with property. You buy it for emotional as well as financial reasons (to stop you paying rent). I had been squeezed out of London because I couldn’t afford to buy a house and was desperate to get on the housing latter before that happened again. FFS…
I am a bit scared by my IO mortgage!
With hindsight, I’m:
a) really glad I got an offset, the flexibility has already been very useful
b) annoyed I didn’t get a longer duration product and taken the hit on a slightly higher interest rate
I wish I’d got hold of that one that (I think) Indeedably found that was just over 2% for the whole lifetime! I’m on 1.54% but only for two years. Now I’m not sure I’m going to have a job in two years time so remortgaging may be problematic.
@The Rhino:
I know what you mean – lifetime IO mortgages at BOE would be great! But they don’t exist except at BOE + X%.
The British mortgage system is a little curious – borrow 4 times your (pre-tax combined) salary, aim to repay over 25 years and your product deal only lasts 2 years.
In 2 years time you have 4 choices:
1) remortgage and keep paying off the mortgage
2) remortgage and cash in your equity to spend on nice things like new cars or a cruise
3) could be out of a job and then in trouble
If all things fall apart, call yourself a mortgage prisoner!
@GFF – I think TI was right to go longer at 5 years, sensible. I’ll have to see what the lay of the land is in 2 years, but worse comes to the worse I should be able to offset it down to a token amount and then sit it out and see if anything changes to allow me to remortgage. Even over the short amount of time I’ve had it, I think its been instructional in giving me a ‘real-world’ lesson in my actual risk-tolerance. By that I mean how I’ve tweaked asset allocation around it and the proportion I have offset.
@vanguardfan. Too true but it shaped my thinking and actions. I see it like pouring champagne into a tower of glasses with the top one being 6 months outgoings.
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I suppose you also need the right mindset and lots of discipline. To see that as paying off your house not to dip into when you need a new, (pick from any or all of the following), dress, pc, ipad, car hifi etc
Those worried about the process and want to get shut ASAP, well wouldn’t this be quicker than a fixed 25 year repayment? Yes you can overpay but then you can add even more higher paying investments.
I suspect this offers more flexibility over the 25 years as over time the investments would cover the mortgage if you lost your job, I doubt they would allow you to increase the mortgage. I suspect you would end up IO anyway until you found work again. Not sure what you would be entitled to claiming unemployment these days. They say if you get into difficulties contact them but what help can they give apart from temp payment holiday but rolling over onto end of mortgage.
Real examples might aid discussion though from anyone actually implementing this in practice
When interest rates were high I was trying to overpay as much as I could afford (which wasn’t much back then). When they dropped like a stone and I found myself in a 40% tax bracket I extended them out to retirement and tried to pay as little capital as possible instead diverting it to my SIPP.
By good fortune those diverted capital payments hit the stock market at the start of a bull run. I just couldn’t have wished for a better state of affairs.
I’m now in my early fifties but my attitude has changed. I’m moving back to prioritising the mortgage; not because I think it’s a good idea financially (it’s not) but because I now think getting rid of the mortgage would make me happier.
I wonder if this is an age related turn of events?
@ Ermine >I was that guy. Buying a house in 1989 is still the single worst personal finance mistake of my entire life.>
As far as I can tell the biggest mistake was not being in possession of crystal ball. I don’t know why you seem to beat yourself up about it. You may as well say your second biggest mistake was selling it and missing out on the BTL boom and price surge. It’s just a narrative.
Of course some of the guys at work warned you about the impending crash. You could buy at the most perfect time ever and the naysayers at work, the pub or, latterly, on the Internet would be warning you off.
Even if we have bad timing luck, we’re still fantastically lucky to have what we have of our health, families, food and warmth, and being born in a time that has technology, medication and sanitation. Life is inherantly risky, probabilities are the best we have – i think overcaution can be harmful, peace of mind is important but people do sometimes feel that unlikely/close to home events are more likely than they actually are
I’m on an interest only offset ( base +1.995) but I have an impending dilemma. The mortgage is on my first house that I kept when I also bought a family house. I’be been renting my first house out on a consent to let. However, the consent to let runs out in 6 months so I’ll either have to pay off the mortgage ( which I can do ), remortgage to a BTL or not renew my tenants AST at the end of term. I like the interest only offset as it allows my to draw down additional funds if opportunities arise. Hmm, what to do ?
I wonder if there are a few more doubters now after the market falls or are they gleeful to buy 10% cheaper with bigger yields.
I suppose the only losers would be those wanting to cash out. That £400k mortgage is now £40k short
Nice article. Found it very interesting as I’m doing this with my B2L. The interest free mortgage is invested in equities. Have been using rental profit to pay off 10% a year to reduce capital and gradually lower exposure to risk of stock market collapse + rocketing interest rates.
I’m considering buying a furnished holiday let in the future and trying to figure out the smartest way to finance it. Unlike residential buy-to-lets, with FHLs you can still deduct 100% mortgage interest from tax, so I need to figure that in.
Don’t be frightened of mortgages. They can be really useful in many ways. Your first mortgage will likely be difficult to get and/or expensive. Almost certainly that will be because you don’t have a credit rating so what do you expect? There is a but! Make sure it does not have an expensive get out clause or unreasonable security requirements to be underwritten by some else like your parents. I once said . NO” to that. The salesman said that was a good call, it proved I was thinking. Lock in periods where you can be charged very high interest rate are another.
I have lost count of the mortgages I have had. In the end I was able to get trade mortgages designed for people who chop and change fairly regularly.
I would advise using brokers over high street banks/societies. They price high to cover themselves for failed mortgages and just because they can over charge.
We are heading for turbulent times We once had 14% interest under Gordon Brown’s government. Make sure you can stand that! It will be hell if it happens again.
A little late to the party.
Very controversial I’m sure for the Dave Ramsey followers.
Excellent points. Risk tolerances definitely measured with a question of do you go for an IOM.
I have to admit we went for a repayment for our first. Clearly I’m fairly risk averse. But I would consider IOM for future ventures. Although I might plan an early exit and risk fund to cover a potential sale during negative equity. But maybe I plan for worse case, despite statistics showing things get better on average rather than worse.
What I wanted to add was the concept of inflation having an impact on the debt. Most of the time we focus on wage growth or the potential capital growth, both valid. I guess it’s one and the same. It’s just a double whammy. Kind of like how I used to be able to get a can of cola and a mars bar for 50p in the 90s. The compounding effects of the value of money eroding with inflation and the potential of assets increasing in value just highlights how good value a mortgage is whatever way you pay it off.
I think that rationale is easier for me too , as potential of other investments doing better than the difference in interest costs are less guaranteed. A ball on a shelf has potential energy. It will need some input to achieve that potential. A room will get messier over time because of entropy. If that makes any sense to anyone other than me
P.s. my name wasn’t on the land registry for my house until I’d paid it off… Maybe it has changed.
One consideration rarely mentioned is interest rate risk. When you first take a repayment mortgage, fluctuating interest rates can have a material impact on monthly costs (you may not notice if you’ve fixed until the end of the fixed rate period). Over time, the principle reduces which has the affect of dampening the impacts of fluctuations in interest rates on your monthly payments.
With interest only, you don’t get this affect, and if you’re investing in shares, you’re exposed to that interest rate risk (ie you could see a perfect storm of shares dropping in price and interest rates rising as we saw at the beginning of the Credit Crunch)
@Marcus – I agree with what you say regarding interest rate risk and this is most apparent among the interest only, no savings/investment crew that you hear about – the ones who after 10 years of a mortgage have not saved a penny and are moaning about being mortgage prisoners a d how they can’t remortgage to the rates reserved for those who are lower risk.
Interest only works great for those with the discipline to save/invest and who have the means to repay should they wish.
In the hands of the precariat, it’s a disaster waiting to befall the foolish.
Side note: lots of articles in the press about IO mortgages these days with 5 year fixed below 2% – when my deal is up I will switch if I can.
What a fascinating post The Investor. I will watch with great interest how it works out for you. Thanks for your bravery and honesty too.
I do have a couple of questions:
You mentioned you got an interest rate of 2.5% in 2020, is that a fixed rate? If so, how long is it fixed for? If it is not, what is the rate today?
On the investment portfolio that you are putting into your SIPP and ISAs, is that 100% equities or is a percentage in non-equities like bonds, cash etc. If so, what percentage is in non-equities.
Thanks
@Zoe — Apologies for the delay getting your comment approved, it got stuck in our system. 🙂 Glad to hear you enjoyed the article.
The 2.5% fix mentioned in the article is just an example worked through for readers. My own fix was under 2% for five years, but it recently more than doubled. This does make the appeal less attractive. I’ll write about this soon on Monevator.
You might find this article (and the linked-to spreadsheet cited in it) interesting for doing your own sums:
https://monevator.com/pay-off-mortgage-or-invest/
Definitely not personal advice, remember a mortgage is a debt and everything can go wrong. Do you own research. Absolutely nothing wrong with taking the safer approach to pay off debt first. 🙂