Should we take out a £1 million interest only mortgage?

[Scandala]

The following relates to London and it will sound utterly absurd to nearly everyone. We live in an ordinary house but have lived here so long we are climbing the walls. Mortgage is paid off (I know we are super lucky). We want to move closer to DCs’ school/s into an area that is sadly far more expensive. Stamp duty is crazy and it seems next step up on housing ladder in this area costs at least £1million more! This is for detached house with parking in leafy street, not mansions. Was astonished to hear broker telling me we are typical of people buying in that bracket and that they all take out interest only mortgages. The interest payments are no more than £1500 a month for £1.3 million. Our equity would be about 60%. Thing is, houses in the target area have soared. If they double in a decade in the same way that our more modest house has then isn’t it a better investment? We are mid-40s and 50 so not young. DC are still in primary school and we have years of school fees ahead of us. Combined earnings mean we ‘qualify’ for that size mortgage and can even go higher. Nervous at thought of starting again though but I guess it’s now or never. Are we mad?

@LizzieMacQueen they are for higher earners

@Lottle

Banks ask how you'll replay the capital, eg a pension lump sum etc. I don't think just selling the house is a valid way. So I'm not sure you'd qualify.

Exactly what I was going to say!

If you were younger I'd say go for it but I'm 50's now and would absolutely not want a sizeable mortgage around my neck . Being mortgage free gives me total flexibility to run my life , I can't tell you how happy it makes me that I can leave work anytime I chose early retirement or leaving work b

I would agree with fixing the rate for ten years and then seeing where things are by then. It's extremely unlikely that prices will be significantly lower after ten years (look at the 90s crash chart). They might well be significantly higher and you might make a killing on it. And that may well be a good point to sell and size down again, depending on your financial and other circumstances.

My dh works in finance and thinks interest only is nuts- but he is very very cautious.

Yeah he must be because it really depends on individual circumstances

It's acceptable to our lender.

It all depends on your attitude to risk...

You can afford the mortgage at current rates,
they are going up,
could you still afford it if after your (presumably ) fixed rate ends and rates are double or triple to remortgage? What is the tipping point at which you couldn't afford it? How likely are rates going to be that high?
You need to be sure you can afford that or would be willing to take the risk of being forced to sell in that instance.
Could you manage if one of you loses your job ?
For how long?
Would there be a likelyhood of job loss being only short lived in your professions? Ie should this happen, you would very likely be re employed at a similar level within say 6 months?
Could you cover 6 months from savings and are you prepared to ring fence substantial savings.?
Do you both have substantial life insurance?Illness cover?
How comfortable are you both with debt? How disciplined with finances (there could be some challenging times)

Those are the essential calculations you should make before anything else.

The upside can be huge, depends very much on exact location, so l cannot comment.
large family homes on good streets, with outside space are a safe bet generally.
Check recent sold prices thoroughly, be critical and thorough about the area and price per square foot.
Lastly would you be happy to downsize to pay off the mortgage.

Its all about calculating the risk, minimising the downside and having a Plan B and C that are well thought out, if you are taking on a big debt.
Most wealthy people have had to take large risks, only you know if that is for you.

I think there's a lot of scare stories about IO which are borne out of the past. If you're financially aware then it's a relatively low risk. I'm assuming that £1.3m in a v nice bit of London equates to a normal-ish home eg 4/5 bed rathe than something that will be difficult to sell on. It's only a problem if you want to stay there and don't have a means to cover the mortgage sum at the end of the term.

We did interest only on our last house (nowhere near as expensive as yours though) and when we sold we paid off the mortgage and had profit left over to the same value, so it worked for us. But i would be terrified by the numbers you're working with

@sashagabadon

I don’t see the financial risk? You will own 60% of an expensive house. That’ll remain the same even if prices drop a bit so you’ll easily be able to downsize later. I think of interest only like renting but without the threat of being turfed out by private landlord with 2 months notice. Interest rates going up are a risk so a long fix is sensible

Well no it won't. Any drop in value comes off the equity as they'd still have the loan to repay.

You do have to think about interest rates - even if you a long term fix. If as you say everyone else is interest only, a rise in rates may mean their loans become too expensive and if suddenly lots of people have to sell, that will reduce your property value.

Could you look at half repayment half io?

I think you are a tiny bit mad because of the figure involved and your ages. But it probably will pay off. We have invested in property and looking back now that they have done so well, (one definitely doubled over the last 10 years and the other on track to) we could have taken on more. We paid ours off though and are receiving incomes from then which gives up options such as we both went part time. I wouldn't want a mortgage now we are almost mid 50's.

@karmakameleon

Also have you considered the cost of stamp duty? Stamp on a £2.8m property is about £250k. And then you’d presumably be selling in ten years, buying a new home and paying stamp duty again.

Good point. And gulp.

I think if you have stress tested the idea to your satisfaction and are happy to downsize later then go for it.
Stress testing to include factoring in;
Interest rate rise scenarios (mitigate by fixing for as long as possible)
Potential for housing market to go down (maybe look at largest % crash in living memory and check it wouldn’t wipe out all
of your equity if it happened now)
Impact of death or illness in either of you (income protection/life insurance)
Pension provision and other investments you have if you were to be unlucky and lose equity
Buying and selling costs
Running costs

If the downside risk is acceptable to you, I’d say go for it and enjoy. You’ll probably do well out of it overall (and even if you only break even, you enjoy the house for now aka renting from the bank).

Stamp duty on a £2.8m property is about £250k

We sold our London House in 2014. Three similar houses have sold since then for about the same price in similar condition. The houses met a ceiling and it is unchanged. Either those prices will remain the same for the next 10 years to effect a natural correction or the correction will be accompanied by a fall in price.

We sold due to concerns about the mansion tax. We moved out a little but still within very easy commuting distance of dd's school and Central London. Paradoxically prices here have continued to rise.

Think very very carefully op. Over 10 years that 1500 adds up to £180k - more if interest rates rise or you invest it wisely. Set that against any potential increase - or potentially your equity taking a hit.

You’d need a long term fix. According to the Bank of England calculator on £1.3mill with an interest rate of

1.5% = £1625 a month
2.5% = £2708

5.5% = £5958

I remember having a mortgage on 5.5% in the 1990s and it was the cheapest one available at the time. If you can insulate yourself from interest rate rises then I can see your logic. BUT if you go get a long term fix you’d be stuffed if you need to move (unforeseen accident/bereavement/divorce).

It all depends on how you both are with risk. The pay off could be enormous but so could the fall.

@Scandala

Thanks for the feedback. Really interesting points. We would never pay off the whole mortgage - it would not be our intention to do that as we would move/downsize when the DC left school. But if we had, say £1.5m initial equity in a £2.8m house and it doubled in value in 15 years then we would have ‘made’ more than if we stayed in our £1.5m house, which if that doubles in value will still always be worth less than the house in the ‘nice’ area. I am normally very risk averse as is DH but we look at friends and colleagues with lower incomes who have taken on more risk and it has paid off.

My parents did this internet only and lived the life. I think in their mind some miracle was going to happen so they'd be able to pay off their mortgage. The date got closer and closer and they had to sell their beloved home. No they didn't need a big house anymore all Dc gone, but they had got used to it. The parking, the garden, the area, their friends and ultimately the status. They moved from a big 6 bed enviable house on massive plot in London to a 2 bed with a small garden in the same very expensive area. It's broken their spirit. It's only their fault, but I just don't get their thinking. Even if an inheritance they eventually got had come earlier they couldn't pay off the mortgage and the bank wouldn't extend past 65.

My parents also had 50% equity.

Not the same situation but interest-only mortgages were the thing for acquaintances working in the kleptocracy able to invest their bonuses more productively in financial assets and get a greater return than the equivalent return from paying down a repayment mortgage while getting the benefits of property price rises.

Friends of mine are doing just this right now.
They see it as cheaply renting for the next 10-15yrs - they have no intention to pay the mortgage off but hope that inflation erodes the debt and they come out of it net but get to live in an amazing house in the meantime.
They are risk takers though, own their own company and some BTL properties.
Never have any cash, they leverage everything and so far it has paid off.

I could never take the risks though and felt nervous about a £250k repayment mortgage.

We have interest only fixed for 5 years we are 2 years into the mortgage and I feel a bit worried that in 3 years they will turn around and say it can't be extended and we have to switch to repayment, which we couldn't afford.

For us the interest only was to allow us to extend and sell so we have a plan, but I just wanted to let you know if the risk doesn't sit with you it will cast a shadow on your life and make you nervous.

Ours is 500k and we have 70% equity in the house currently, I really don't think I could gamble with 1million plus.

@NewHouseNewMe which areas do you think have peaked in London out of interest? Nope no inheritance to speak of (maybe 100k if not eaten up by care costs etc). We have another two small rentals in a ropey area that will never be worth that much but keep them in good condition and rent them low, attracting loyal tenants. We probably have 450k equity in those due to rising market but capital gains tax would massively deplete this when we go to sell. We have ISAs, DH has OK pension and mine is a bit rubbish. We have some in crypto but I do not bank on this at all. Another two investments in the tens of thousands but those again not guaranteed. I should say all of this is down to DH having boring job in same company for years and our frugal natures, driving cheap second hand car etc, no luxury holidays, no cleaner. We never buy new furniture, I own zero designer clothes. Take home pay will be 10k a month shortly. (Again realise we are lucky. Posting this on Investment forum to see other perspectives, not as a brag). We come from zero money backgrounds and help our DPs financially when needed. I would put school fees ahead of house as a priority. Just wondering though if we are doing ourselves a disservice by NOT leveraging more. Our mantra has always been zero debt but am coming to realise that those who are truly well off always take out debt, especially in an inflationary market where your money is worth less. I realise we are massively privileged by the way and that London house prices and jobs are massively out of line with how of the UK lives.

I should say all of this is down to DH having boring job in same company for years and our frugal natures, driving cheap second hand car etc, no luxury holidays, no cleaner. We never buy new furniture, I own zero designer clothes. Take home pay will be 10k a month shortly.

Surely it's down to having a highly paid job as opposed to not having a cleaner!

Well it’s both. High earnings combined with keeping outgoings low.

What is the stamp duty on what would be a third home?