Repayment v Interest only

[RavenVonChaos]

Okay some friends told me I should have a interest only mortgage but save each month and pay off up to 10% of the mortgage over a year. Would this work out cheaper?

I am really confused

The idea with an interest only mortgage is to save or invest over the term of the mortgage to build a lump sum which will pay off the mortgage. If you are simply paying an amount off each year you would be better off having it on repayment as every month your interest drops (admittedly minutely) as you owe less. Most people on interest only will look to invest in the stock market so that they will (potentially) get out a lot more than they invest, repaying the mortgage quicker or giving them a lump sum of cash once they have repaid the mortgage.

Why do they think you should have it on interest only?

You get flexibility with an IO mortgage - I have one, but I treat it as a repayment mortgage and save at least the repayment amount (and almost always more) into an offset account linked to the mortgage. But it does mean that if I lost my job I could revert to just paying the interest and could even do so from the savings account. I do think you have to be very disciplined though.
Banks don't give them out often these days.

Not sure about it being cheaper. Depends on the rate though I would be surprised if the interest rate on an IO mortgage was lower. I am currently thinking about taking the money out of the savings account and putting it in an ISA - returns currently better (though it is more risky).

There's a fairly good summary of the features of Repayment vs Interest Only here. Interest only has its place and it's certainly worth doing the maths but you have to plan your savings strategy very carefully or you can easily end up in the position that those who took out Endowment policies are at the moment... i.e. not having enough saved to pay off the capital.

My guess would be that you'd get a better deal (better interest rate) with a repayment mortgage and that, if you shop carefully, you can also pay off lump sums without penalty... best of both worlds.

No lender will give you a new interest only mortgage these days without you putting in place a formal repayment investment to repay the capital at the end of the term. This has been imposed by the FSA.

The only exception is the case of a customer having difficulties in meeting repayments, when their mortgage provider might allow them to move to interest only as a short term measure to help them over a difficult period. It would only be allowed to carry on for a matter of months, though.

Thanks for the replies. You have confirmed what I thought. I think at least one mate is freelance so likes the flexibility of having a smaller mortgage. We are just about to buy a new house bit want to pay it of quickly really, so will have a repayment morrgage and try to overpay every month.