Mortgage & Housing

25 September 2009

Managing Director, Worldwide Financial Planning writes:

Mortgage owners everywhere are being asked to seek mortgage advice on their methods of repaying their mortgage – apparently. Or so the headlines go.

When a customer takes out a new mortgage they have a choice on whether or not to take out a repayment or interest only.

What’s the difference and which is better?

A repayment mortgage consists of two parts: the interest repayable to the bank on the money you owe at that time, plus a portion of the capital repaid over the term of the loan which is typically 25 years. At the end there is no mortgage. And that is the advantage they have – a guarantee that the mortgage will be repaid.

An interest only mortgage however means that you simply pay interest to the building society and no capital. At the same time there is an expectation that you will be saving into a plan to create enough capital at the end of the term to repay the mortgage.

The risk is that the plan doesn’t have enough capital at the end to repay the mortgage.

There are a number of benefits to an interest only mortgage over a repayment that homeowners should consider:

Firstly inflation erodes away the true value of your debt. A £100,000 mortgage taken out 25 years ago would be the equivalent today of £40160 today as inflation took its toll. If you fell short of your mortgage by 10% it would only be £4,000 in today’s terms; (1)

Most people expect an inheritance and that can easily be factored into (but not relied on) an equation when considering how vital repayment plans may be.

In order to understand what is most appropriate for you, you should consider the behaviour of most mortgagees: As a mortgage is considered the most effective way to borrow, many homeowners continuously borrow and top up against their property over the term of the mortgage.

Is it therefore wise to have a repayment mortgage which you ‘sort of pay off’ then top up then pay off and so on. Each transaction is expensive with layers of extortionate fees and it seems peculiar that homeowners would force them selves through such expense when a more flexible method is available. If the mortgagee had been saving into a savings plan such as an ISA or unit trust they would simply be able to tap into the savings plan and take what they need as and when they needed it;

Furthermore let's consider flexibility.

Many people today are worried about jobs and their ability to repay the mortgage every month if they lost their job.

A customer who has saved separately into a savings plan would now have the ability to take that cash and fund themselves through a difficult period where their repayment counterpart would be at the mercy of the bank (heaven forbid) agreeing to change to interest only at best, but more likely in default if they couldn’t make all the payment. Cash flow is king. I would be happier having £10,000 in a savings plan to fund me through a hard time than having paid £10,000 off my mortgage and not be in a position to make any payments.

Business owners and buy to let owners receive tax relief on their payments so why would they want to reduce the debt if it’s so tax efficient.

An interest only mortgage allows the flexibility to make payments as and when they are suitable. Forget endowments, but the flexibility of ISAS and unit trusts allows the mortgagee to save to accumulate the fund to repay the mortgage, but also to decide to make lump sum payments back as and when there is a need.

For example, consider the well-advised homeowner who was told to stay on a standard variable rate today. They would be furious if they were making capital payments at this level. The investor in an ISA would be enjoying the stock market return but ready for the potential of super inflation and high interest rates at which point the ISA could be encashed to lower the debt. Flexibility for market conditions is everything.

If you have a financial or mortgage query call Peter on 0845 230 9876, e-mail info@wwfp.net

Source:
(1) www.thisismoney.co.uk

Your home may be repossessed if you do not keep up repayments on your mortgage
Think carefully before securing other debts against your home

Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
The above represents the personal opinions of Peter McGahan.
All information is based on our understanding of current tax practices, which are subject to change.
The value of shares and investments can go down as well as up.