High Court explains compound interest to property investors

[Steven Barrett]

It's shocking they didn't sell in 2016 when they could have.

Cases like this remind me of the episode of The Simpson when Homer gets his arms stuck in two vending machines. After they fail to dislodge his arms, they say the only option is amputate his arms. Just as the saw is starting up they ask: "Homer, are you still holding onto the sodas?"

When it comes to property in Ireland, people are willing to hold onto bad investments, even though it means years of fighting with banks and vulture funds, impact on their health, family life and relationships.

 

[qwerty5]

I love excel, what's the pmt function?

Payment. (https://www.ablebits.com/office-addins-blog/excel-pmt-function-formula-examples/)
e.g.
=pmt(rate per month,total number of payments,principal,0)

So for a 600K mortgage with a rate of 3.7% over 20 years the formula would be

=pmt(3.7/12,20*12,600000)

or €3541 per month.

So once you understand that it's easy to create formulas that reference different cells so you can calculate variables like what it means if you get 3% cashback at the start and pay a slightly higher interest rate. Or calculate what the difference extra repayments make etc. etc.

Obviously we never know the long term interest rate will be, but it helps when deciding what will get you the best bang for buck.

 

[qwerty5]

Qwerty

Don't be surprised if you hear me say that on a radio programme some day. It's a great line.

Brendan

Shall we discuss royalties

 

[Buddyboy]

When it comes to property in Ireland, people are willing to hold onto bad investments, even though it means years of fighting with banks and vulture funds, impact on their health, family life and relationships.

Ah yes, the sunk cost fallacy.

 

[lff12]

It's both bad investment and the failure to understand compound interest.

I have seen this time and time again. "I borrowed €300k 20 years ago. I have repaid €200k but I still owe €200k!"

Brendan

I think the problem in this case was that they went interest only for a very considerable period - thus they are repaying both the capital and the interest.

End of the day they would have been FAR better off simply investing in a normal pension.
This is why consulting a proper financial advisor rather than trusting luck with your money for retirement is always a good plan.

 

[ClubMan]

I think the problem in this case was that they went interest only for a very considerable period - thus they are repaying both the capital and the interest.

This seems to be contradictory. Interest only means no (scheduled) capital repayments during the lifetime of the loan.

 

[Purple]

End of the day they would have been FAR better off simply investing in a normal pension.
This is why consulting a proper financial advisor rather than trusting luck with your money for retirement is always a good plan.

Well said.

 

[lff12]

This seems to be contradictory. Interest only means no (scheduled) capital repayments during the lifetime of the loan.

Its not - it means that they still have both capital and interest repayments liable, even if they only have to pay interest only during the term of the loan - it still means at some point the lender can call in the capital element, which is exactly what the lender did in this case.

 

[ClubMan]

Its not - it means that they still have both capital and interest repayments liable, even if they only have to pay interest only during the term of the loan - it still means at some point the lender can call in the capital element, which is exactly what the lender did in this case.

That's not what you said here:

thus they are repaying both the capital and the interest.

You don't pay capital on interest only.

And, presumably, the lender called in the capital prematurely because the borrowers defaulted on their interest only repayments and thus breached their contractual obligations?

 

[lff12]

That's not what you said here:

You don't pay capital on interest only.

They had too once the loan is called in. If you borrow 300k to buy a home and pay interest only, the capital element STILL has to be repaid at some rate - so for example a 25 year mortgage with a 25 year interest only term will have 300k capital to repay at the end, or if there is a 15 year interest only term followed by a 10 year interest and capital period, its 1125 a month at a rate of around 4% for 15 years followed by 3109 a month for the last 10 years.

Worked examples: 300k with 10 year fixed term interest only (from comparethemarket.com) - albeit at UK high BTL rates, but you can see that the cost is far higher

Representative example
Borrowing £300,000 over 25 years, representative APRC 7.6%:
Initial term
122 payments of £1,395.00 at 5.58% (fixed)
End rate
178 payments of £2,235.00 at 8.94% (variable)
Total interest
£567,520.00
Total upfront fees
£1,295.00
Total amount payable
£868,815.00

And for same amount, full repayments:
Borrowing £300,000 over 25 years, representative APRC 7.0%:
Initial term
122 payments of £1,856.62 at 5.58% (fixed)
End rate
178 payments of £2,280.53 at 8.94% (variable)
Total interest
£331,941.60
Total upfront fees
£1,295.00
Total amount payable
£633,236.60

It costs more because the repayments for the interest only period don't pay anything off the capital, meaning the cumulative interest ends up being much higher. That's why interest only has been so devastating for BTL buyers from the early 00s in this country, where people bought in the expectation of short term capital appreciation, assuming that would both clear off the loan liability AND leave them with sufficient profit to clear any other costs.

 

[elcato]

End of the day they would have been FAR better off simply investing in a normal pension.
This is why consulting a proper financial advisor rather than trusting luck with your money for retirement is always a good plan.

Except what did they actually invest here ? I suspect the 900k they did manage to pay over the years consisted of rental income.

 

[Bronte]

It costs more because the repayments for the interest only period don't pay anything off the capital, meaning the cumulative interest ends up being much higher. That's why interest only has been so devastating for BTL buyers from the early 00s in this country, where people bought in the expectation of short term capital appreciation, assuming that would both clear off the loan liability AND leave them with sufficient profit to clear any other costs.

These were extremely popular and easy to get, much encouraged on here.

 

[Gordon Gekko]

People tell lies unfortunately. My friend had tenants who stopped paying. Then they claimed they’d done work on the property. They did actually, albeit on an unauthorised basis, something that wasn’t needed. They claimed it was the reason for non payment of rent and wanted to agree an offet.

Enter the tradesman to the rescue…they’d stiffed him and hadn’t paid him!

 

[lff12]

These were extremely popular and easy to get, much encouraged on here.

Central Bank did a whole paper on this circa 2013 or so. Showed a huge amount of BT loans were taken out around 2004 or so that were maturing from around 2007 to as late as 2015 or so. But there was a large bump switching to capital and interest after initial interest only terms specifically between 2011 and 2015. Which perhaps provides some explanation why rent appreciation was so high from 2012 to 2015.

Of course, one point I forgot to mention was their comment that they should have "invested in a pension instead". They probably borrowed most of the cost of purchasing the apartments so probably didn't actually have that much to put into a pension either. One of the key issues with BTL tiger era investing was that so many of the investors were nor borrowing from pre existing financially secure positions.