Interest Only Mortgage Payment
I had a chat with a mortgage advisor in the recent past and he advised
me that a faster way of paying off the principal owed on a mortgage
(i.e. gaining equity) is to 'overpay' an interest only mortgage rather
than take out a repayment mortgage. Does anyone know if this is true?
Does the idea have something to do with the fact that when you get out
a traditional repayment mortage, the early payments are mostly made up
of interest with only a little of the monthly mortgage payment going
towards the principal? Conversely, with an interest-only mortage, as
the interest payments are the same each month, if you overpay, the
overpayments are directly 'eating away' at the principal more quickly -
is this right?
It's not true.
basically a repayment mortgage is exactly the same as an interest
only one, but that it includes an automatic provision for overpaying.
It all boils down to *how much* you want to overpay and when. The
standard-recipe repayment plan chooses to keep the total monthly
payment constant, because it it believed that that is what suits most
people best. Personally, I rather doubt whether that's really the
case, because as people's income rises, both through inflation and
as a result of career advancement, they may prefer to channel some
of the extra cashflow into boosting their repayments in order to
clear the debt sooner and reduce the total amount payable.
All things being equal (say 6% and 25 years and £100k borrowed),
an IO loan would cost you £500 a month and a typical RP loan would
cost £644.30, so you are already overpaying more than £140 each month.
If you were to regularly overpay an IO mortgage by £144.30 each month,
you would have paid off the debt in 25 years too.
You may think that £144.30 per month * 300 months only adds up to
a bit over £43k, which is less than half the debt, but you must
remember that as soon as you overpay anything, you will be charged
less interest because the debt has shrunk. Therefore not all of the
£500pm scheduled for interest-only will be needed for interest, and
the excess then also contributes to capital reduction.