Coming into some money - pay off half of interest-only mortgage or invest so can eventually pay it off in full?

[FungalToeBogeyman]

We took out an interest-only mortgage pre-recession, when our circumstances were very different and we were in a position to save towards repayment.

A few years later, DP, who was a high earner, developed mental health difficulties which affected his ability to work. Now, I'm the main earner, and my job is much more modestly paid. So while we can afford the monthly interest payments, we can't put more than a few hundred away each month towards the eventual repayment. The outstanding borrowing is £260,000.

In a few months, very luckily, I'm due to come into some money, and it will be enough to pay off nearly half the mortgage – a bit over £100,000.

What I'm wondering is, do we pay off a huge chunk of the mortgage with this money or, where the interest we pay is very low (1% over base rate), would it be better to invest it and, by the end of the mortgage term (about 20 years), have enough (with average growth of 5%) to pay it off in full?

I like the idea of seeing the overall borrowing reduce by nearly half, and knowing that when interest rates rise, we'll be able to afford the payments comfortably. However, even with nearly half the mortgage paid off, we still won't have the means to repay in full simply by saving each month, especially when interest rates rise. Nonetheless, we want to keep our settled DC here if at all possible.

My financial adviser recommends investing the money, at least initially while interest rates are still low in relation to the return we could achieve by investing, but I'd just like to get a second opinion.

What do others think? What would you do?

Thanks.

Thank you for the further posts. It's good to know we seem to be on a sensible track with the plan we've arrived at.

I take on board the point several of you raised about ensuring the £100,000 or so I pay off the mortgage is reflected officially in the equity split; I'll look into this.

I've had a useful (very quick!) initial conversation with the lender, and over-payment is, as I thought, permissible at any time, and any amount. So this one-off repayment will be fine.

The lender did, however, say that it would like to see evidence of the repayment plan we have in place. It's not an issue if this is something we will be setting up anew at the time of paying off this chunk. What they're looking for is an endowment policy (really?!), a stocks and shares ISA or a particular type of pension (of a kind I don't have).

I'm going to call them again tomorrow to ask for their list of permitted repayment arrangements in writing, so I don't go organising the wrong thing, but as things stand, it looks as though I need to set up a stocks and shares ISA as soon as possible, in order to be able to make the part-repayment shortly.

So ... stocks and shares ISA advice next, please! Any ideas? Although I've always been a pretty disciplined cash saver, I have no idea about stocks and shares ISAs. How long do they take to set up? Perhaps I might put up another post tomorrow after speaking to the lender again.

Oh, and thank you ReallyTired for that information about council tax banding - very useful.

Thank you all again.

This is a very interesting thread actually. I have suddenly re-thunk all the numbers thrown at me by the media about property price increases. On a second home or buy to let you have to reduce that increase by a third because you pay CGT on it.

So if you bought your property in Birmingham for £100k and it went up to £110k in 3 years time you have only made £7,000.

And those mansions that go up in price by 10% in London have actually gone up by 7%. They are nearly always second homes, or third or fourth or fifth.

"
So if you bought your property in Birmingham for £100k and it went up to £110k in 3 years time you have only made £7,000."

In that kind of senario you would not be liable for captial gains tax. You do have a captial gains allowance and if you are married and jointly own the property then you can use both partner's captical gains allowance. Each individual has a captial gains allows of £10,600. A married couple could gain 21K before they have to pay any tax.

I think you would need to get financial advice on how to minimise captial gains tax. There are different rates depending on your income bracket.

You also make money in rent which is taxed. I don't think that captial gains tax is any worse than income tax. People don't choose not to go out to work just because they have to pay tax.

www.hmrc.gov.uk/cgt/intro/basics.htm

I agree this is an interesting thread.

CGT for most making a biggish profit over 15 years is likely to be 28% (it used to be 40% so do note taxes go up and down) and 0% on your home. If you make a smallish profit then yes it might be under your £10,600 a year capital gains tax free limit or only taxed at 18% if you don't have another salary or the other salary is low but in most cases selling a buy to let to make £10k is silly - it's not enough money to make it worth the agents', solicitors fees and your costs on the property over the years. Most people selling buy to lets therefore probably are making profits big enough to pay 28% capital gains tax.

My daughter's buy to let makes no profit after expenses by the way even with London rents although may have gone up in capital value and needed a new £2000 boiler this year which may well be more than the capital increase. Buy to let is not the huge money spinner tenants like to think or the pres thinks and most buy to let owners own only one property and spend a lot of time dealing with it.

If anybody is interested, the reason the top rate of CGT is now 28% is this: back when the top rate was 40%, you were allowed to deduct 'indexation' from the gain (simply put, indexation took account of the fact that prices rose from the date the asset was bought until the date it was sold). So the net rate was usually a lot less than 40%.

Incidentally, it's capital gain. Not 'captial' gain!

Laura this is different to your daughter's case because there won't be a mortgage on the property. What it would give her is an instant and fairly hassle-free income if she charges a decent rent on a small place.

One of the reasons people fail with btl is that they charge too much rent and tenants will resent this especially if the property is cold or there is a problem.

Any sensible landlord factors in over time, the costs of new boilers, furniture etc and would set aside at least 10% of the income for those purposes.

People buying large properties as btl are not making a good choice as they have a lot of use, 6 people using a bathroom is going to cause a lot more damage than 1 or 2. My suggestion was a 1 bedroom property in an apartment block in the centre of a city which means even if you have to drop the rent, you will always have tenants.

Making a profit on the capital of a btl is where most people make their biggest mistake. They assume a price increase and that makes them spend more on their debt which leaves them at risk and with no leeway if tenants don't pay.

And if you have £10,000 a year CGT, CGT isn't going to be an issue on a £100k property.

I think having a self-contained unit in the garden is a great idea but OP still has to pay CGT on it. However that might still be the better option for her as it will be easier to manage and she has money left over to reduce the mortgage.

The OP could get an agency to manage the property for her. I suggest she picks an agency which is ARLA registered. ARLA letting agents have to take exams to show that they have some knowledge what landlords legal responsiblities are.

I think a big problem with buy to let landlords is greed. It is essential to do some maintaince on a property each year to attract a high quality tenant. I put aside £400 a year out of £6000. Some years I spend more and some years I spend less. It is often worth doing some non essential maintaince to keep a tenant happy. (Ie. painting a back gate)

"Any sensible landlord factors in over time, the costs of new boilers, furniture etc and would set aside at least 10% of the income for those purposes."

100% agree. There are good years with btl and bad years. Also if you have a good tenant then you are shooting yourself in the foot by charging too much rent.

Fungal - I would ask about changing the remainder of the mortgage into repayment and get quotes for that rather than setting up a stocks & shares isa.

The reason being that it would be much better to have a guaranteed repayment plan for your mortgage than one that relies on growth in the market such as an endowment plan or a stocks & shares isa.

if you want to hedge your bets you could take the repayment over a longer period, thus keeping the payments low and use any monthly excess to go into an ISA.

The OP mortgage allows voluntary repayments. She doesn't have to make any changes to her mortgage. See the post by FungalToeBogeyman Thu 16-Jan-14 23:29:05

The OP might find it really hard to remortgage as her income is substantially lower than when she took the mortgage out. Setting up a stocks and shares isa is a matter of shopping around for the deal you like best.

We've already established that the OP isn't going to get a buy to let (thank goodness!!)

Changing her mortgage to repayment is crazy behaviour unless she is forced to by the bank. If she has an interest only mortgage she should keep that at all costs and overpay to make a dent in the capital wherever possible. Interest only mortgage gives her flexibility to adapt to her circumstances and she loses this if she changes to a repayment mortgage. Changing from interest only to repayment is crazy unless you're so undisciplined that you genuinely can't trust yourself not to make the overpayments.

What's the difference financially, long-term, though between IO+payments and repayment? If you made payments by the book on an IO are you better off long term than on a repayment?

Excuse my ignorance in these matters I have never had an IO mortgage, they didn't exist when I took my first one out back in the day.

Redsquirrel building a building in the garden and letting it out is the same thing as a BTL, it's just in the garden and won't achieve such a high rent.

It is true I am somewhat risk averse .

Call me boring, but nothing helps both me and DH get through work with a little more of a spring in our step than the knowledge that provided we keep making the same payments to our repayment mortgage, we will be debt free in 10 years. All safe and certain and no relying on chance or the stock market.

Maybe it's because I used to sell Endowment mortgages in the early 90s when I first graduated from college that I have this attitude, I don't know.

Horsetowater - the advantage of making overpayments on a repayment mortgage is that you start to pay off the capital as well as the interest, in fact you pay a small bit of the capital off each month just through the normal payments.

If you make standard payments on an Interest Only loan, then as the name suggests, you will only ever pay the interest, leaving the full balance at the end of the term.

It may be possible for OP to change mortgage type with existing lenders without going through a new mortgage application process, if of course she wanted to, but fine I'm just a risk averse curmudgeon.

www.telegraph.co.uk/property/propertyadvice/9659119/Home-front-Expert-advice-on-annexes.html

This might interest you OP.

She wasn't proposing that though, she was proposing converting her garage and renting it out using the rent a room scheme.

Besides its not the same thing, its adding value to her existing property rather than purchasing another.

No difference with the overpayments on an IO mortgage than having a repayment mortgage as long as the interest isn't calculated (and therefore reassessed) annually.

If you have a £200k mortgage and you are on a repayment mortgage requiring you to pay say £2k a month in mortgage payments then if something happens to your income and you can't pay the £2k each month you have a problem.

If you have a £200k mortgage and you are on an interest only mortgage then the sensible thing if you are paying off through overpayment rather than having a different repayment vehicle is to pay £2k each month. Part of this is interest and part (the overpayment) will be put towards overpaying the capital. Next month if you make the same payment the interest element will be slightly lower and the capital part is slightly higher - exactly the same as a repayment mortgage so far.

The difference comes if for some reason your income is affected. If you lose your job and your income is hit you only have to find the interest element since you're not obliged to make the overpayment.

Yes ok long term if this situation doesn't change you might have to sell your house but you can hold out for much much longer and also, should you chose to do so, you could stay in the house and treat it as a rental to be sold at the end of the mortgage term.

Our interest element is £570. To rent this house would cost us £3k a month. Its very cheap "rent" if we need it to be.

The OP shouldn't give away that flexibility unless she has to.

I understand that bit rookie but I wonder whether paying of £500 a month on a repayment mortgage is financially better than paying £250 on an IO with £250 payment.

When you go to sell you have spent the same amount of money monthly but who is better off?

I'm a risk averse curmudgeon too, never even got an endowment as I thought it was risk. Rarely got into debt.

We established she should not remortgage as she has a very very very low interest rate which would be lost if she remortgaged so the money she saves from paying £100k off the mortgage she should just save up and once a year pay what has been saved off the home loan.

£100k paid off the mortgage if the interest rate is say 3% over next few years say saves her £3000 a year.

£100k put into a buy to let if you live in a part of the country where nay property is to be had for that price which anyone might want to rent - she will need to set a good bit of that aside for legal and estate agent fees and a bit to do it up - perhaps that might leave £95k if she's lucky. She might rent it out for say £500 a month = £6000 a year, taxed at say20% assuming she has other taxable income too less some expenses and letting agent fees if she uses them - ours charged £2000 in year 1 as letting agent fee by the way plus the £2k boiler that had to be replaced and some repairs the tenants wanted done ... so let us say she has about £5000 a year of net interest after tax
Year one might look like £3k interest saving v £5000 rent BUT she had the purchase costs of the property etc of about £5k so in fact in year 1 she is better off paying off the loan even if she can make £5000 a year after tax on the rent.

Fungal
repayment plan in place
You do not need to invest in ANY product at all.
You just need to be able to prove that you have an understanding of how you will pay off the capital.

My Mortgage spreadsheet is as good a place to start as any - download it and then on the "capital repayments" part, work out where they will come from

no need to switch to a repayment mortgage either.
If you can show that your earnings will allow you to overpay £1000 a month off the capital, but you will keep the interest payments frozen at the higher level, that "repayment plan" will have the mortgage at zero by the end of the term, despite it being an Interest Only

I know my method works because I and my clients use it.

horsetowater
have a play with my mortgage spreadsheet too - it makes it a lot clearer to many people

Yes I understand that an IO mortgage gives you a lot of potential to spend money and 'live beyond your means' (not a judgement - it's a choice and depends on circumstances) but if the property was worth 100k when you bought it and is worth 100k when you sell it and both parties have spent the same monthly amount on their repayments, who comes out with a lower debt/greater profit - the IO or the repayment person?

horsetowater
on the IO, if you've only paid the interest, you still owe the capital
because there has been no "repayment vehicle"
allowing such mortgages was one of Broon's MOST stupid moves
with a repayment, the capital is paid along with the interest
look at the spreadsheet - the value of the house is irrelevant to the calculation

horsetowater its the same that the point. Its the same but you have greater flexibility.

And I'm not living beyond my means thanks very much, I can make my mortgage payments (including the repayment sum and a significant overpayment) four times over each month if I really want to.

Why do people persist in branding anyone with an interest only mortgage as some sort of idiot.