I had a chat with a mortgage advisor in the recent past and he advised me that a faster way of paying off the principal owed on a mortgage (i.e. gaining equity) is to 'overpay' an interest only mortgage rather than take out a repayment mortgage. Does anyone know if this is true?
Does the idea have something to do with the fact that when you get out a traditional repayment mortage, the early payments are mostly made up of interest with only a little of the monthly mortgage payment going towards the principal? Conversely, with an interest-only mortage, as the interest payments are the same each month, if you overpay, the overpayments are directly 'eating away' at the principal more quickly - is this right?
I think the idea is that if you move your mortgage (e.g. get a new loan to get another property) in the short term, after 3 years say, then when you take out the new loan you would have actually paid off more of the principal than you would have if you had taken out a standard repayment mortgage.
I think the point is that you pay off *more* of the principal in the early years than a corresponding repayment mortgage, so you need to borrow less when you get out a new loan. Not sure if this works, though!
No, basically a repayment mortgage is exactly the same as an interest only one, but that it includes an automatic provision for overpaying.
It all boils down to *how much* you want to overpay and when. The standard-recipe repayment plan chooses to keep the total monthly payment constant, because it it believed that that is what suits most people best. Personally, I rather doubt whether that's really the case, because as people's income rises, both through inflation and as a result of career advancement, they may prefer to channel some of the extra cashflow into boosting their repayments in order to clear the debt sooner and reduce the total amount payable.
All things being equal (say 6% and 25 years and £100k borrowed), an IO loan would cost you £500 a month and a typical RP loan would cost £644.30, so you are already overpaying more than £140 each month. If you were to regularly overpay an IO mortgage by £144.30 each month, you would have paid off the debt in 25 years too.
You may think that £144.30 per month * 300 months only adds up to a bit over £43k, which is less than half the debt, but you must remember that as soon as you overpay anything, you will be charged less interest because the debt has shrunk. Therefore not all of the £500pm scheduled for interest-only will be needed for interest, and the excess then also contributes to capital reduction.
Possibly he is thinking that if you move your mortgage to a repayment mortgage, there will be charges involved which won't happen if you just overpay an interest only mortgage.
for the same amount of money paid at the same time, I am quite sure that it will work out the same. Ask him to show you a detailed calculation with the same total monthly payment in each case.
There are a few things to consider though:
1) The timing of the payments will make a difference, e.g. overpayments may allow you to pay off more money earlier, which will save you money in the long run. However, you have to have more money sooner to be able to do this.
2) Check the conditions of your mortgage - making overpayments, or overpayments over a certain amount, may incur charges.
3) It is possible that you will be able to make overpayments that are higher than you would like to commit to. E.g. say your mortgage interest is 500 a month, and a repayment mortgage would be 700 a month. You may find that at the end of most months you can afford to make an overpayment much greater than 200. You would then pay off your mortgage sooner that you would with the repayment mortgage. You could of course take out a repayment mortgage over a shorter term, but you may not want to do this if you cannot be certain that you will be able to make such a large payment every month.
4) You can have a repayment mortgage and make overpayments. If the conditions of your mortgage limit the amount you can overpay without charges, this is a good way to increase the amount you can pay off.
5) It depends what the lender does with the overpayments, e.g. When I make an overpayment I have the option of reducing the mortgage term or reducing the monthly payment.
6) The flexibility of making overpayments could be useful. For example, interest rates are quite low at the moment, so you may be in a position to make quite large overpayments. However, over the next 25 years it is quite possible that interest rates will be much higher. Say that you have an interest only mortgage and the interest rate rises to a level where you need to reduce your overpayments. No problem, you just reduce it. Now imagine the same interest rate but with a repayment mortgage.
that's the biggest load of flannel i've heard - and after 20 years in sales i've heard a lot - he's 'selling' you a specific mortgage, make no mistake - in the shadow of poor performance and companies being sued for bad advice left, right and centre, selling endowment policies nowadays must be like selling fridges to eskimos - and that sounds like a desperate attempt
assuming he's comparing like with like (same interest rate, other conditions), any overpayment on either type of mortage comes directly off the capital - in fact it would be quicker to overpay on a repayment (rather than interest only) since you are 'already' paying off the capital (that's built-in to your monthly payment) - so he's either lying or stupid - either way a bad advisor - the significant difference between the two types is in how the market performs over the next # years
if you have any savings what so ever (even your salary payments), i recommend an offset mortgage (offset your savings against your borrowing) - i took one out less than six months ago and i have already paid more off the capital than the previous 15 years endowment (interest only)
obviously the lowest possible interest rate is the priority - that accepted, nothing can compete with an offset mortgage if you have savings
whether you pay all your savings off your mortgage (and leave yourself with zero-savings) - or whether you offset it makes not one penny difference - but offsetting has a least a dozen advantages (at least one should be immediately apparent) - hence your suggestion cannot possibly compete - secondly, no savings account (incl tax-free isa) can compete interest wise with savings offset
You have reached the point where i say "and they give you a 20K bonus each year", and you say "but that means i'll have to buy the mother-in-law a nice present"
You can be as deliberately obtuse as you feel - and you 're obviously trying to convince yourself rather than anyone else
bottom-line is still where you came in
interest-rate aside - nothing can compete with an offset mortgage if you have savings
in your case you are paying max interest on any monies you have whether it be 10K earning a pitance in an tax-free isa or 15 stuffed under your matress earning nowt
You're not listening. I don't have any money set aside, it comes off the mortgage in the knowledge that I can get it back within a few days if I need to.
Your whole argument relies on ignoring the interest rate which makes it a nonsense anyway plus I pay 4.89% on part of my mortgage and could get over
5% on an isa if I wanted so your point is just plain wrong.
I don't think that last part is true - I have several saving accounts which pay a higher rate of interest than I pay on my mortgage:
1) Cash ISA, which I am in the process of transferring to an account which pays 5.2 percent (old account recently dropped from 5 to 4.75 percent which is still higher than my mortgage).
2) Several regular saver accounts, the highest of which pays 10 percent. Unfortunately, these account have strict limits on the amount I can pay in every month so I cannot just remortgage, put 200k in and live off the interest. However, since I get paid monthly it is quite convenient to make a regular monthly contribution.
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