Are there any disadvantages of an Intrest only Mortage?

drunkmonkey · 03-09-2008 11:52am #1

I've a friend who is looking at in intrest only Mortgage for 5 years.....he's looking at borrowing 150k over 20 years.....are there any major disadvantages of going intrest only for the first few years....?

helimachoptor · 03-09-2008 12:17pm

drunkmonkey wrote: »

I've a friend who is looking at in intrest only Mortgage for 5 years.....he's looking at borrowing 150k over 20 years.....are there any major disadvantages of going intrest only for the first few years....?

Well he wont own any capital, all the money he's paying will be going to the bank and none of it will be reducing the amount he owes to them.

jackal · 03-09-2008 12:19pm

Well the obvious disadvantage is that the money they are paying for the first few years is not gaining them anything. If its cheaper than the cost of renting the property then thats ok, but they are still taking all the risk of the property losing value and going into immediate negative equity. There is also the shock of coming off the interest only mortgage. Is there a good reason why they will be able to afford the full repayment in a few years or is it just based on hope. If someone cannot afford to pay a repayment mortgage, going interest only is not the solution, sooner or later they will have to start coughing up.

They were generally used by property investors looking to cash in on captial appreciation. In the current environment, I cannot see any use for them.

drunkmonkey · 03-09-2008 12:20pm

helimachoptor wrote: »

Well he wont own any capital, all the money he's paying will be going to the bank and none of it will be reducing the amount he owes to them.

But he'll be reducing the intrest owed, will he end up paying much extra back or will he still have to pay back the same amount?

drunkmonkey · 03-09-2008 12:24pm

jackal wrote: »

Well the obvious disadvantage is that the money they are paying for the first few years is not gaining them anything. If its cheaper than the cost of renting the property then thats ok, but they are still taking all the risk of the property losing value and going into immediate negative equity

it's a commercial mortage, the intrest only period would allow the business to get off to a flying start....
It shouldn't go into negative equity as the property is worth about 8 times the value of the mortgage......

SimpleSam06 · 03-09-2008 12:29pm

drunkmonkey wrote: »

But he'll be reducing the intrest owed, will he end up paying much extra back or will he still have to pay back the same amount?

Ouch. No, you don't pay off the interest first and then the capital, you can keep paying interest until the cows come home, and you'll still have to repay the full mortgage plus interest at the end of it. Where is he getting a buyer that will sell him property at 12% market rates? Or is he putting down the bulk of the payment upfront?

drunkmonkey · 03-09-2008 12:30pm

SimpleSam06 wrote: »

Ouch. No, you don't pay off the interest first and then the capital, you can keep paying interest until the cows come home, and you'll still have to repay the full mortgage plus interest at the end of it. Where is he getting a buyer that will sell him property at 12% market rates? Or is he putting down the bulk of the payment upfront?

he already owns the property and there is no mortgage on it...

SimpleSam06 · 03-09-2008 12:46pm

drunkmonkey wrote: »

he already owns the property and there is no mortgage on it...

So hes putting his hands on some capital based on his property? Not a bad idea, tbh, fluid cash is worth a lot more to a business than paper value. IO mortgages are the equivalent of paying rent, which he can write off as a business expense. It all depends on what he plans to do with the money, really.

drunkmonkey · 03-09-2008 12:50pm

SimpleSam06 wrote: »

So hes putting his hands on some capital based on his property? Not a bad idea, tbh, fluid cash is worth a lot more to a business than paper value. IO mortgages are the equivalent of paying rent, which he can write off as a business expense. It all depends on what he plans to do with the money, really.

The majority of it is going into the business....the few years with intrest only would be a big advantage, the only worry is he might end up paying a lot more back in the long term, would he?

jdivision · 03-09-2008 1:00pm

Yes he would

drunkmonkey · 03-09-2008 1:08pm

jdivision wrote: »

Yes he would

any idea how much extra..

lets' say 150k @5.7% is €1046.82pm over 20 years, total of €251,236 repayable

how much would the total loan cost if you went intrest only for the first 5years? and kept the term at 20yrs

jdivision · 03-09-2008 1:12pm

He'd have paid about 43k in interest after five years and then have to increase his monthly premium in order to pay back the loan and interest in the 15 years after that

ZYX · 03-09-2008 1:18pm

drunkmonkey wrote: »

The majority of it is going into the business....the few years with intrest only would be a big advantage, the only worry is he might end up paying a lot more back in the long term, would he?

Not necessarily. I had a similar discussion with SimpleSam06 on a different thread today. It all depends on inflation, (general inflation, not house price inflation) Say he borrows 100,000 at 6%. If inflation is running at 5%, then the real cost is about 1% in 1 years time. In other words in 12 months time €105,000 will be worth the same as €100,000 is now.

drunkmonkey · 03-09-2008 1:21pm

I understand the repayment would go up after 5 years, but would 43K be knocked off the total loan or would it be on top if the loan, i.e you would end up paying back €295k in total as opposed to €251k

SimpleSam06 · 03-09-2008 1:21pm

drunkmonkey wrote: »

The majority of it is going into the business....the few years with intrest only would be a big advantage, the only worry is he might end up paying a lot more back in the long term, would he?

Commercial enterprise is nothing like residential property specuvesting, though. If he's reasonably sure he can realise equivalent profits or similar gains for the business in the near future, and most businesses could, it could be worth it. If on the other hand he just wants to go on the mother of all holidays, well, you reap what you sow, especially in a recession.

jmayo · 03-09-2008 3:06pm

drunkmonkey wrote: »

I understand the repayment would go up after 5 years, but would 43K be knocked off the total loan or would it be on top if the loan, i.e you would end up paying back €295k in total as opposed to €251k

As Simplesam said earlier he is not decreasing the capital amount he owes.
Thus he starts off owing 250k in year 1 and he still owes 250k in year 5.
It should mean he has more cash to play with in those 5 years, since he has not being repaying the capital, he has just being paying the interest owed on it. He is deferring his capital repayments.
After year 5 he will then starting paying back the 250k and the interest on the borrowed amount.

In the lifetimeof the loan interest rates may go up or down, keeping track with inflation and the property may go up in vlaue or even go down in value.
The latter does actually happen in sane economies.

Repolho · 03-09-2008 3:23pm

Ignoring inflation, it will cost your friend approx 14,500 to go interest only for 5 years.

years 1-5 = 8,550 (150,000 * 5.7%)
years 6-20 = 14,899 (150k/ 15 years @ 5.7% = 1,241.60 pm)
Total Cost = 266,238

versus

Years 1-20 = 12,586 (150k / 20 years @ 5.7% = 1,048.85pm)
Total Cost = 251,724.

This ignores the time value of money.

Using 4% as a discount rate, the total extra cost amounts to only 3,170 (174,220 vs 171,050).

Are there any disadvantages of an Intrest only Mortage?

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