Are interest-only mortgages useful if you plan to move again soon?
While there is an increasing amount of bad-press surrounding interest only mortgages, are they worthwhile if people plan to move house in near future, and where do repayment vehicles fit in?
Drawing on years of experience, industry award-winning mortgage expert Ray Boulger - of mortgage broker John Charcol (www.charcolonline.co.uk) - answers your questions.
Stephen in Belfast asks:
I am in the process of moving house and will be taking a sizable mortgage, in excess of £300,000. I know now days most people go down the repayment mortgage route, however, is there any merit in investigating going interest only with a savings vehicle, on the basis that if we move in say 5 years we wont be starting from scratch again, or this financially much more expensive to consider. I am looking at a 25 year mortgage but would love to be in a position to pay it off much sooner.
There is no reason why arranging the mortgage on a repayment basis should be any more expensive than the combined cost of mortgage interest and the contributions you make to a separate repayment vehicle.
This depends of course on what repayment vehicle you intend to use. It is for this reason that you must speak to an investment expert to find out what investments may be suitable for you, what level of risk they carry and their expected rate of return net of tax.
Arranging your mortgage on an interest-only basis is only more costly if you either don't combine it with an investment that has a higher net rate of return than your mortgage, or if you don't make the agreed payments when you are supposed to.
For example: £300,000 on a repayment basis (assuming 4.99 for the first two years then an average standard variable rate of 6.65 per cent) over 25 years would cost you £604,581 in total over the term of the mortgage, so £2.02 for every £1 you borrowed.
If you arranged the mortgage on an interest-only basis however it would cost you £789,816 over the term of the mortgage, so £2.63 for every £1 borrowed.
If you opt for an investment vehicle you need to find one that will have a return net of tax of £300,000 plus the £185,235 interest, by the end of the term.
This is not unreasonable because, in the same way that your capital interest amortised down, your savings will compound up.
This means that the interest you make is added to your lump of money then next time, the interest is applied to your higher amount of money, including its own interest from last time.
Repayment basis mortgage payments for the scenario above would be around £1,750 whereas the interest only payments would be £1,250. This means that you would have £500 a month to contribute to your investment vehicle, so £6,000 a year.
If you happen to be in a couple your level of debt is convenient as two of you would have an annual allowance of £6,000 to put into cash ISAs which are tax free.
If not, you will need to find an investment where the rate of return (after tax has been deducted) is higher than the interest rate on your mortgage.
If you are intending to combine your mortgage with a savings account a tracker for the term of the mortgage may be a good idea because not only have you got more chance of it staying roughly in line with what savings accounts offer but it means that you don't have to factor remortgaging costs into your equation every few years.
However a variable rate is only appropriate if you have a healthy attitude to potentially rising interest rates and scope for higher payments.
An alternative way to reduce your monthly commitment would be to take the mortgage on a 30-year basis or more.
If you ensure that whichever mortgage you chose has some sort of overpayment facility and you can overpay into it when you have the funds available.
This way you have a 30 year 'worst case scenario' but the chance to pay it off quicker. This is a less risky approach than taking a pure interest-only mortgage and making totally discretionary overpayments every month, which is only appropriate for people of exceedingly strong willpower.
Finally, you mention that you would reassess your mortgage in five years' time so please be careful that you don't repeatedly postpone your debt repayment to the point where you don't have a decent term left before your retirement.
Inevitably you must strike a balance between comfortable mortgage payments and the risk you are willing to take.
If you have a question for Ray, go to www.myfinances.co.uk/askthemortgageexpert
For more information on the issues discussed here, go to www.charcolonline.co.uk or call 0800 358 5560.
Charcol Limited is authorised and regulated by the Financial Services Authority (FSA registration number 427339). The FSA does not regulate credit cards, personal loans or some investment mortgage contracts. Some Buy To Let mortgages are regulated by the Consumer Credit Act (CCA).