Interest Only Mortgages - Are They a Good Idea?

Many people opt for an interest only mortgage for one
simple reason - it's the cheapest option.

You can't blame people for choosing the 'lowest' cost
option, can you?

So how does an interest only mortgage work (I've had many
clients call it an interest free mortgage - if only!), as
against the other option of a capital repayment loan?

With an interest only mortgage, you only pay back the
interest on the mortgage every month. So, for example, on a
£150,000 mortgage you would cut annual payments by around
£3,000 as opposed to the repayment option.

But of course this means that you are not paying off any of
your debt - the capital. And at the end of the loan term
you would still owe £150,000.

If you want to repay capital from day one of your loan,
then you need to take out a repayment mortgage. This
spreads the interest and repayment into one monthly
payment, typically over 25 years. This then guarantees to
pay off your debt.

So, lets look at costs.

For a £150k loan at say 6% over 25 years, the difference
per month would be circa £222. So you could say that over
the 25 years you have saved £66,000 - but at this point you
have to pay back the lender the £150,000.

It is also true to say that over the term of the loan, the
interest only route will mean you will actually pay more in
interest.

Why?

Well, if you do not pay back any of the £150,000 capital
debt, the lender will charge you interest on the entire
loan for the entire term. Whereas with a repayment
mortgage, you are trying to get rid of your debt from day
one and you will therefore gradually chip away at it until
it's all gone - meaning the debt gets smaller which affects
the amount of interest you pay overall.

On this sort of example, the interest saved would be around
the £80,000 mark.

So, ideally, we should all have a repayment mortgage.

Clearly, using the interest only route when you are
struggling to cover costs as a new buyer is perfectly valid.

It is also worth mentioning that the following reasons
could be part of an overall strategy that a doctor/dentist
can use:

- maturing policies/pensions<br> - pay more later re
promotion/private practice building<br> - using offset
accounts and "parking" tax monies/spare cash<br> -
downsize<br> - sell "buy to lets" in future<br> -
inheritance

All of these are perfectly valid, but do not put your head
in the sand, plan, and plan well.

The Financial Tips Bottom Line:

As you can see, the interest only route has its merits,
however the negatives outweigh the positives. If you have
recently purchased a property with an interest only loan,
make a point of reviewing it (perhaps when your deal comes
to an end) and switch to a repayment mortgage when the
timing is right.

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Ray Prince is an Independent Financial Planner with
Rutherford Wilkinson plc, and helps UK Resident Doctors and
Dentists get the best deals on mortgages, protection and
investments, as well as helping them achieve their
financial objectives. Just visit
http://www.medicaldentalfs.com to get your free retirement
planning guide. Rutherford Wilkinson plc is authorised and
regulated by the Financial Services Authority.