By UK Property Investment Expert Andy Shaw...

Repayment or Interest Only Mortgage?

In reply to the question from Chris "When you invest in property do you have interest only or repayment method, I have heard arguments for both, what is your opinion"?

This is huge subject that I'll be coming back over in a few different ways in the future.

Let me start by saying how I discovered which was best and that may help you more than me just giving the answer straight off the bat.

It was around April 2002 that I discovered the answer to this. I had already started to buy property in bulk, I just hadn't completed on any yet. Of course I was buying with interest only Buy-to-let mortgages. This was because there was no way the rents would stack up with repayment mortgages.

One of the reasoning's I'd come to in the time of researching the property market was an example that was quite close to home - My Dad.

He had bought his home on the 4th January 1971 for £5,600. He took out an endowment mortgage, which on the 4th of February 1996 matured and gave him I think about £6,500. He promptly paid off his mortgage and they sent him the deeds.

When he took his mortgage out, he was paying a fixed rate, which I think he got over the entire term (Dads a bit woolly on finances). He was paying £41/mth, which consisted of £26 interest and £15 endowment (these were the figures he gave me at the time and I know there not totally accurate now, but it's the gist I'm looking to get over here).

My Dad was a schoolteacher all of his life and in 1971, his monthly income was about £100 net. Things were very tight for my parents and would have remained so for a long time, if my Mum had not started a business, which gave us all a comfortable life.

Dad struggled to make ends meet but never missed a payment in his life. He paid that £41 right up until he paid of his mortgage.

By 1996 Dad was retired, he had a school pension, a government pension, stocks and shares, in total he had an unearned income of around £20,000 a year or £1,667/mth. The £41 a month that he paid on his mortgage didn't even raise his eyebrow anymore.

His current account always had £5,000 in it, let alone any deposit accounts, he could have just written a cheque and paid off his mortgage and not even noticed it. But the endowment that was still costing him £15/mth paid it off instead.

The mortgage as a percentage of his income in 1971 was 26%.

The mortgage as a percentage of his income in 1996 was 1.56%

The endowment as a percentage of his income in 1971 was 15%

The endowment as a percentage of his income in 1996 was 0.9%

(Obviously my intention here is for you to look at the endowment as if it were a repayment of the mortgage)

So if my Dad had paid interest only in 1971 he would have been 15% / month better off. Which is obviously a massive percentage of his take home pay.

Then in 1996, he would have had to pay just 25% of his annual income to clear his entire mortgage.

Is time powerful or what!

There is absolutely no financial gain in having a repayment mortgage at all - it is an illusion! It is pure peace of mind rubbish.

Furthermore a repayment mortgage is based on the assumption that you actually want to pay your mortgage off!

If anybody wants me to expose that assumption in another article just let me know.

I knew all of this and still struggled with changing my own residential mortgage over to an interest only one. In the end I had to con myself into it because my brain, sorry my programming wouldn't accept it.

I had been so severely programmed by my parents, the media, the government, and the banks to pay off my mortgage, that I could not bring myself to stop my repayment mortgage.

Even though I had proved to myself beyond any doubt that I was better off on interest only.

So I tricked myself into it, I had to agree with myself that we'd try it for a while and we'd give it one year and if that didn't work then we'd switch back to a repayment mortgage and ‘we'd fell better that we'd tried and it had failed.

Anyway, I suckered my brain into it and it let my hand dial the number and my voice say, "please convert my mortgage to interest only".

The following month the payment came out of my bank. My repayment mortgage at the time was quite high, around £2,800. When the interest only payment came out it dropped to around £1,600.

I could not believe the wave of relief that came over me, it swept my programming away in an instant and I was able to use another one of the powers of property in my favour.

The answer is - Interest only 100% no doubt in my mind.

That was 2002; in 2003 I refinanced my home and pulled out around £200k, which I used to fund a large part of my portfolio.

My interest only payment jumped up to around £2,800 (what I was paying as a repayment mortgage before).

Since I converted to interest only, I have missed I think 40 repayment payments, which would mean my mortgage would be paid off by £48,000. Obviously I've paid the interest element!

At this time I am re-financing some of my extensive portfolio as I am consolidating my old portfolio, whilst building others, with my business partners.

My consolidation is to put all my buy-to-let mortgages into 3-5year fixed deals on a cheap interest rate and pull out a seven-figure sum as a fall back protection against bad weather.

The money I'm pulling out will pay down my mortgage to around £10,000 on my own home and a similar amount on some of my other key properties. I do not want to pay off my mortgages because the lenders are happy to allow me to draw back down at any time, up to my total mortgage within the 25 years term.

I digress...

The point I'm trying to make, even though I can't seem to make it is - Why pay off debt today with real money now, when you can pay the debt off in years to come with the same sum of money, but that money is worth much less then!

(I can't seem to get that sentence right, if anyone can put it better, please let me know as I'm a bit rushed today)

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