A client and her husband are moving home and plan to top up their present interest-only mortgage which is secured by two low-cost endowments.
They had decided on repayment for the top-up. “Why?” I asked. Well, they have lost confidence in the low-cost endowment route, although they plan to continue with their present policies.
I pointed out that an endowment is not the only option alongside an interest-only mortgage – what about an Isa? However, they are already contributing to an Isa as a safeguard against a possible shortfall on the endowmentsand do not want to commit any more to that particular medium.
Fair enough, I said. But, even so, is a straight repayment mortgage the best route?
Its undeniable attraction is the certainty of clearing the mortgage by the end of the term. Its downside, though, is that it is the option which affords the least control over any plans you may have for early reduction of the capital, for the simple reason that it demands the highest monthly payments to service the loan.
As we all know, an unpleasant aspect of a repayment mortgage is that for at least the first half of its term, almost all the monthly payments are applied as just interest, with no repayment of the capital at all. Only for the last two-fifths or so of the term are your monthly payments applied to reducing the capital.
A much better strategy would be to go for an interest-only (flexible) mortgage but from the word go, make payments as if it were a repayment mortgage. Right from the very first month, every payment in excess of the interest required to service the loan reduces the capital and thus the amount of interest chargeable.
If you maintain the same level of payments, with every passing month the capital will reduce by a steadily accelerating amount.
The result should be that,for no greater outlay than a conventional repayment mortgage, you should clear the capital much more quickly because you will be paying it off at the front end of the mortgage term instead of towards the end. That has to mean less interest payments.
Also, if interest rates should increase, instead of seeing your total monthly payments go up (which is what most homebuyers dread), all that will happen is that the rate of capital repayment will slow a little.
You can always increase your monthly payments, if and as circumstances allow, to maintain the same level of capital reduction.
Surely, this has to be the best way to repay a mortgage as it gives the greatest degree of control over their capital repayment schedule instead of placing it in the hands of the lender, as well as avoiding the uncertainty of the performance of a related investment product?
It does require a degree of self-discipline but, I would suggest, no more so than an Isa-linked mortgage. Subject to the client's attitude to risk, few advisers have much to quibble about with those, provided,of course, that investment performance and the client's chosen funds are regularly reviewed, which is what we are all supposed to do anyway.
Am I the first to think of this or is it a well kept secret or is my reasoning in some way flawed?
WDS Independent Financial Advisers,