Is it advisable to pay off £20k from a £100k interest-only mortgage or instead invest that amount? DAVID HOLLINGWORTH offers his insights.
Rewritten Article:
Here's the scoop: Our fixed rate mortgage, with both a repayment and an interest-only compartment, has seven more years left to run. There's £200,000 on the repayment side and £100,000 on the interest-only side, all while having £20,000 in stocks sitting pretty to tackle the interest-only part. Setting sail in a higher interest rate sea now than before we embarked on our current five-year fix, we're looking at a hike from 1.4% to approximately 4%.
Now the question is, should we continue on the current £200,000 repayment journey, along with the interest-only £100,000 level, and stick with our £20,000 invested fund, or shall we use part of that £20,000 to attack the interest-only loan head-on, jump ship, and begin anew investing the remaining £80,000 to erase the debt? For all things mortgage-related, our friendly broker lends a hand, David Hollingworth!
David Hollingworth shares his insights:
A mortgage can be structured in two primary ways - capital and interest repayment or interest-only basis. The former works by gradually reducing the mortgage as each payment covers both interest and capital. This approach comes tagged with (you guessed it) lower risk since you're making progress towards your total repayment.
But taking the interest-only path means your payments cover just the interest - sound familiar? That's when you need another contingency plan ready, such as a separate investment vehicle, to hopefully grow enough to repay the mortgage by the end of the term.
More often than not, the mortgage decision is presented as an either/or scenario, but it's possible to split your mortgage and have a mix: part repayment and part interest-only.
While the interest-only method opens the can of worms of uncertainty about whether your repayment vehicle will flourish enough to meet the pending mortgage amount, it's essential to keep that repayment vehicle under constant review.
So, there you have it - let's dive deeper into our two potential routes:
One, Uproot the £20,000!
Pulling out £20,000 to wipe out the interest-only side seems clear enough - it'll diminish your monthly mortgage payment remarkably (around £67 less a month at 4% interest). Super attractive, huh? But hold up, double-check the actual balance before doing the deed. You may not need to worry about such a massive leap in payments as you've likely made significant strides over the years on such a low rate.
> Keen to compare repayment vs interest-only? Give our calculator a whirl!
Two, Invest to Eliminate the Interest-only!
Ready to give investing a go? Splendid! But let me remind you - you got zero crystal ball to predict how the investment will fare in the long haul[1]. Always get expert advice on your specific investment, considering the money turbulence we've experienced lately[2].
Tally up and liquidate the £20,000, and presto - you're clearing the £20,000 off the interest-only chunk. That leaves you starting fresh, investigating new ways to pay off the remaining £80,000. But beware, ensuring growth in a shorter span of time (nearly seven years left) might demand a heavier monthly commitment.
Compounding over time remains a crucial driver of growth, but what really matters is the time required to reach the goal of filling up the £100,000 pot[3]. Getting instant advice on necessary contributions monthly will help you confidently move forward.
But How Could £20,000 GROW?
Ever wondered what £20,000 could do in seven years? Well, David cautions:
Aesthetically speaking, it could balloon to about £30,407 at a 6% annual return, after costs are whittled away[3]. Adding regular monthly contributions would be necessary for a healthy £100,000 target.
At a 4% interest rate on the remaining £100,000 interest-only loan over seven years, monthly interest payments amount to £333[4].
If you sink £20,000 and start the £80,000 journey afresh, by investing at a 6% return over seven years, you'd need £770 monthly to hit the new £80,000 target[4].
That's an extra £163, highlighting the benefit of compounded returns on your existing capital[5].
Feeling even more ambitious and thinking of removing £20,000 and ditching the interest-only loom, then shifting to a repayment loan with the remaining £100,000? Well, the £1,095 a month payments might put a bit of a damper on things.
The numbers don't lie - investing to clear the interest-only portion only makes sense if the returns on your investment surpass the mortgage rate, ideally in a tax-friendly environment like an Individual Savings Account (ISA)[6].
Tread lightly, though - investing isn't guaranteed. Stock markets can tumble down, shoot up, or tangent around. Sticking to your mortgage levels provides a touch more certainty.
- Our current mortgage, with both a repayment and an interest-only compartment, includes a £200,000 repayment side and a £100,000 interest-only side, while having savings of £20,000 in stocks set aside for the interest-only part.
- With interest rates rising from 1.4% to around 4%, we ponder whether to stick with our current mortgage plan or use part of our savings to attack the interest-only loan head-on and start anew, investing the remaining amount to erase the debt.
- David Hollingworth, our friendly broker, offers financial advice on mortgage-related matters, suggesting that a mortgage can be structured either on a capital and interest repayment basis or an interest-only basis, with the former reducing the mortgage gradually as each payment covers both interest and capital.
- Taking the interest-only path means your payments cover only the interest, requiring another contingency plan like separate investments to potentially grow enough to repay the mortgage by the end of the term.
- It's possible to split a mortgage and have a mix, part repayment, and part interest-only, but there's uncertainty about whether your repayment vehicle will flourish enough to meet the pending mortgage amount.
- Considering investing £20,000 to clear the interest-only side, David advises calculating the actual balance before making the decision, as you may not need to worry about a massive increase in payments due to the low initial rate.
- If you choose to invest £20,000 to eliminate the interest-only loan, ensuring growth in a shorter span of time might demand a heavier monthly commitment to achieve the goal of filling up the £100,000 pot in the remaining seven years.
