Interest Only Mortgages - Whats the catch?

Hi

I'm about to move home and have been advised that an interst only option is the way to go as I expect (do'nt we all!) my earnings to increase in the coming years making future payments more manageable.

I'm a bit cautious though as it means that my Capital remains lingering!

What do you guys think?
Any thoughts / suggestions aprreciated

Are there any hidden dangers in Interest only mortgages that I'm missing?

Thanks

Who advised you ? a banker?

How do you propose to pay off the capital sum at the end of the loan ?

You will pay a lot more interest over the life of the loan with an interest only mortgage.

Interest only mortgages!! I just cannot fathom why the banks are shoving these down our throats. They totally rely on capital appreciation of the property to get any type of value from the investment. Is it just me or does this seem like a final attempt by banks to strain every last cent from this property bubble!

Hi Lansdowne

Interest only mortgages are very appropriate in many circumstances.

With repayment mortgages, the typical pattern is that someone buys a house and scrimps and saves to make capital repayments as well as interest repayments. After a few years, their salary has increased and the mortgage repayment becomes very low as a percentage of their income. They then regret that they made so many sacrifices when they were younger.

I would recommend that anyone buying a house should opt for an interest only mortgage at the start. When the house is sorted and the repayments more manageable, then you can start paying off the capital.

I am not recommending that you go on 3 holidays a year and change your car every two years instead of paying off down your mortgage. I am recommending that you don't live a miserable life just to make repayments which would be a lot easier later in life.

Theoretically, there is nothing wrong with having an interest only mortgage for your entire life. Say you buy a house today for €300k and you borrow €300k interest only. You will be paying interest on the loan for the rest of your life. But some people pay rent on their home for the rest of their life. In twenty years, the interest will be very small if your income has doubled.

Brendan

You buy a house and get mortgage of 400K and pay interest only for 20yrs on it, house could be worth 1M but you still owe the 400K, If this was an investment property then profit would be 600K minus tax,but if it is your main house then you have to sell the house to pay the 400K

I would recommend that anyone buying a house should opt for an interest only mortgage at the start. When the house is sorted and the repayments more manageable, then you can start paying off the capital.

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Whilst I see what you are saying Brendan, I think there are more issues, and the circumstances of the borrower must be looked at.
Firstly, in this instance, Lansdowne is moving house - most likely trading up, perhaps (s)he would be as well to purchase a property at a price wherein (s)he can afford the capital and interest repayments, rather than extend themselves to such an extent that interest only repayments are the only option in order to have a decent quality of life. Another factor here is that, if someone is stretched to such an extent that interest only is the best option, they will be extremely sensitive to increases in interest rates, even the 0.25% rate increase can result in a massive increase in repayment (see for example the recent increases of 0.25% in Dec and again in Mar - these would have increased a typical interest only repayment by approx 20%).
Secondly, if Lansdowne after trading up has not yet managed to secure the home of his/her dreams, then, if there is a property downturn in the next few years will (s)he not be in a much worse position in terms of trading up again?
Thirdly, as interest rates are at their all time low, would it not be advisable for a home owner to pay off as much capital as possible (lifestyle permitting) in order to reduce the interest element of mortgages when rates do go up.

dodo said:

You buy a house and get mortgage of 400K and pay interest only for 20yrs on it, house could be worth 1M but you still owe the 400K, If this was an investment property then profit would be 600K minus tax,but if it is your main house then you have to sell the house to pay the 400K

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equally, the house could be worth 200k and you still owe 400k...

dodo said:

You buy a house and get mortgage of 400K and pay interest only for 20yrs on it, house could be worth 1M but you still owe the 400K, If this was an investment property then profit would be 600K minus tax,but if it is your main house then you have to sell the house to pay the 400K

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You can keep remortgaging indefinitely and your estate can sell the house when you die.
or
Your earnings will have increased sufficiently to make paying off the €400k a lot easier.

Lansdowne is moving house - most likely trading up,

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I hadn't interpet this as trading up. I would be less enthusiastic about an interest only mortgage for someone trading up. In the current market, you should really only trade up if you have to or if you are getting a really great bargain. It is ok to stretch yourself financially to get on the housing market, I don't think that you should do it every few years.

Thirdly, as interest rates are at their all time low, would it not be advisable for a home owner to pay off as much capital as possible (lifestyle permitting) in order to reduce the interest element of mortgages when rates do go up.

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I have seen this argument a lot and I don't agree with it. As interest rates are low, it is a good time to borrow. You buy things when money is cheap. When interest rates rise, you should pay off as much capital as possible.
You can argue that you should start paying down your mortgage now as interest rates are fairly sure to rise. But they will still be comparatively cheap.

Brendan

I agree with all sides of the argument. We bought our current property with an interest only mortgage 2 years ago. We would have had no life only for we went with the interest only mortgage. We are trading up now and probably stretching ourselves a bit more and plan to have an interest only mortgage for the first year in order to still pay the full amount into our SSIA's. So in our case it has helped us alot, but I agree you have to be careful about it.

Brendan said:

With repayment mortgages, the typical pattern is that someone buys a house and scrimps and saves to make capital repayments as well as interest repayments. After a few years, their salary has increased and the mortgage repayment becomes very low as a percentage of their income. They then regret that they made so many sacrifices when they were younger.

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I would disagree with this. This seems like the kind of thing people always say in retrospect, youth is wasted on the young and all that. I suspect anyone who buys their first home and subsequently has to scrimp and save would still have had to do so on an interest only mortgage, they'd simply be living in a bigger place.

Most ftb's will take the maximum amount that a bank will lend them and then buy accordingly.

I believe an interest only mortgage simply exposes them to greater, short term, risk. 1. Because they can borrow bigger amounts (40% of disposable income?) 2. They are more open to interest rate fluctuations.

Again, anyone who bought in the last 5 years when rates were going down or nowhere would definately have been better off on an interest only mortgage, regardless of the fact that house prices increased in value. However, given the current interest rate outlook, for the short to medium term I don't feel it's a good idea.