Borrowers turn to interest-only mortgages – how to invest and pay off your loan
For example, a borrower with a traditional £ 100,000 mortgage withdrawn at 2 percent over 25 years would pay £ 424 per month in repayments. The same terms on an interest-only deal would only cost £ 167 per month, which is a difference of £ 257.
If the homeowner invested the £ 257 and got an average return of 4.5 percent, they would make £ 140,251 after 25 years. This would allow them to pay off their mortgage and have £ 40,251 left before the fees are taken into account. Alternatively, if their investments reach £ 100,000, they could pay off their mortgage about five years early, saving £ 10,020 in interest payments.
However, if the returns were lower at 1.5 percent, they could expect a return of £ 93,350 after 25 years, leaving them tight at £ 6,650. If a broker charged a typical rate of 0.75 percent per year, it would leave the borrower only £ 84,700 and a shortfall of £ 15,300.
Other factors also play a role. Mortgage rates are currently low, but it is unlikely that it will stay that way forever. An increase in interest rates would increase monthly payments and decrease the amounts available for investment.
The approach leaves borrowers at the mercy of the markets. Should the stock market crash shortly before the mortgage term expires, it could leave a significant void.
Mr. Hollingworth added, “If returns are lower than expected, the borrower could be in debt longer. Interest only can be a useful option, but for those who understand that risk. “
In the 1980s and 1990s, in addition to endowment insurance, companies often only sold interest rate deals, many of which did not perform as expected. After the financial crash in 2008, millions of interest-only borrowers were left with no repayment options.
Only interest-bearing borrowers are also at a higher risk of negative equity. If a borrower fails to repay their debt and house prices fall, they could owe more than the home is worth.
The rules have tightened significantly since the financial crash and lenders are now only considering lending on an interest basis to those who already have significant equity in their homes.
The more conservative way
Borrowers looking to prepay their business early can consider regular overpayments instead. This can significantly shorten the life of a mortgage and sometimes save thousands of pounds in interest payments.
Most deals incur early repayment fees, especially fixed-rate contracts, but often up to 10 percent of the remaining loan can be overpaid each year.
With adjustable rate mortgages, fewer rules apply and sometimes there are no limits on how much a borrower can overpay.
If a borrower on a £ 100,000 mortgage over 25 years overpaid 2 percent by £ 50 a month, they would save £ 3,821 in interest over the life of the business and pay off their mortgage three years and four months early.
An overpayment of £ 100 a month would save you £ 6,689 and allow you to pay off your loan in less than 20 years.