MORTGAGES – Interest Only or Capital Repayment?

MORTGAGES – Interest Only or Capital Repayment?

13:55 PM, 30th June 2022, About 2 years ago 29

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My personal view is that an interest only mortgage is far better than a capital repayment mortgage, here’s why …

Back in 1971 my parents borrowed three times their joint income to buy a house that cost them £3,000. Yes you read that right, THREE THOUSAND POUNDS, and that bought them a three-bed house in South Staffordshire.

They put down a 10% deposit and took on a mortgage for the balance of £2,700. It was a real stretch for them because mortgage interest rate were five times higher than they are now.

Their bank manager persuaded them with financial logic they they would be far better off having a 15 year repayment mortgage, so that’s what they did, despite crippling their household cashflow. It was a Bank Manager’s financial logic, NOT the financial logic of an entrepreneur.

Now let’s fast forward to 2022, the house is now worth £300,000. If they had taken an interest only mortgage of £2,700 their monthly repayments today, assuming say a 2% interest rate, would be just £4.50 a month.

Was it really worth crippling their cashflow all those years ago, forsaking holidays and “making do”?

What if they had taken interest only mortgages and remortgaged their property, say every 10 years, and used the funds as deposits to buy more properties to rent out? Might they be multi-millionaires by now? I think they might well have been,

However, life never really turns out exactly as you planned does it? The reality was that after 10 years my parents took on a second mortgage to pay for double glazing, a new front door and to build a garage. A few years after that they sold their property and purchased a much bigger and more expensive one, again with a much bigger mortgage. They were always on the verge of being broke as a result of the advice their bank manager had given to them.

On the other hand, my brother and I did things very differently. We always took interest only mortgages and refinanced as much equity out of the properties as we could, to serve as deposits to buy more properties. However, we didn’t take big risks (in our opinion) because we also hoarded the cash we would have been paying if we have taken 15 year repayment mortgages. Our thought process was very simple; if we needed cash we had repaid on our mortgages we would be at the mercy of the banks to lend it to us. However, if we had the cash we were in control of our own destiny.

This strategy worked out well for us both, because life always throws you a ‘curve ball’ every so often. Sometime interest rates went up, tenants stopped paying rent, properties were vacant and producing no rent, unexpected maintenance issues occurred and a few properties got trashed. It didn’t hurt us too much though, because we had cash in the bank to deal with these scenarios.

Also consider that as property values fall it gets harder to borrow. When dealing with a crisis position, e.g. a desperate need for cash or unaffordable mortgage payments, would you prefer to have a slightly smaller mortgage or extra cash in the bank?

Why repay low interest rate debt and then borrow back at higher margins when you need cash?  Property Investment involves positive cashflow and management of liquidity.  In my opinion, there is no sensible argument for making capital repayments on the mortgage, especially if you are still expanding your portfolio or may need to access funding for other purposes.

My Property Investment Strategy

The beginning of my career was spent working in financial rescue and the underwriting of risk.  It was the late 1980’s, property values had plummeted and interest rates had soared to 15%.

Property investors who faced financial ruin at that time all had one thing in common, and it wasn’t what you might think.  It wasn’t high gearing, despite the crash in property values, it was a shortage of cash.  Investors with high gearing and high liquidity (cash in the bank) fared well.  This taught me that “Cash is King” and that equity left in property is subject to high risk.

Why I believe property investment makes so much sense

Vast quantities of people choose not to own their own home for a variety of reasons and prefer to pay rent for the privilege of occupying property.  In fact, in the early 1900’s over 90% of people in the UK lived in rented accommodation.  This fell to a low point in 1973 to just 7% of the population.

The basics

I use rental income to service mortgages and the management, maintenance and insurance expenses associated with property ownership.  Over time, inflation and other factors increase the value of my properties and the rent.  However, my mortgage balances remain constant, assuming of course that only interest is paid.  Therefore, as the years roll on the gap widens between the rents received and the total outgoings thus creating an improved cash flow position.  Rising property values also increase my net worth.  A strategy of borrowing ‘cheap money’ to purchase property is, therefore, an effective method of accelerating my wealth by using other peoples’ money.

Why I released equity whenever a realistic opportunity to do so presented itself, especially during my first two decades in this business

It’s all about transfer of risk.  If equity is left in the property and the property reduces in value the equity may no longer be accessible and I am taking all the risk.  However, once the property is refinanced, I control the liquidity and the risk is transferred to my lenders for which they earn premium interest returns.

The following simple example might explain this better.

Let’s assume I own an investment property worth £100,000 with no mortgage.

One morning I wake up, turn on the TV and watch the news which announces that property values have fallen by 50%.

My property is now worth £50,000.

Prior to this happening I could have raised a mortgage of £75,000 and kept the money in the bank.  I would then have a property worth £50,000 and a mortgage of £75,000.  Therefore I would have £25,000 of negative equity!

Would I be at risk though? Remember, I would still have £75,000 in the bank.

So what are my choices?

I could feel sorry for the bank.  After all, the bank are now carrying the risk.  If this is the case I could repay the mortgage, or,

I could simply keep the money in the bank, or

I could use part of the money to buy more cheap properties and keep some on one side for a rainy day.

If I had not refinanced I might well find it difficult to raise money as the banks would be nervous about lending at this point.  If I then decided to get funding I would probably pay more for it.  Additionally, if I could then borrow 75% of the value of my property, I would only manage to raise £37,500.

If the market goes the other way and property values increase then another window of opportunity may well open to release even more equity.

What are your thoughts?


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Comments

John Spring

15:17 PM, 1st July 2022, About 2 years ago

My position is properties held in joint names with my wife we are both in our seventies approx £1,000000 mortgages outstanding IO repayable at age 85 approx 1.5/2m IHT liability at the present time lump sum in bank attracting 0.5% interest I am contemplating paying off the mortgages by age 85 if I can accumulate the cash should I / can I obtain a 30 year mortgage therefore mortgages will be repayable at death if I can should I borrow as much as possible therefore giving me additional cash what can I then do with the cash other than spend it any observations or suggestions would be greatly appreciated

Mark Alexander - Founder of Property118

19:22 PM, 1st July 2022, About 2 years ago

Reply to the comment left by Ian Narbeth at 01/07/2022 - 11:35
Hi Ian

I think your summary is a very good one. However, there are ways out of this trap. I found myself in this position many years ago and was very angry when somebody wrote about it on another forum. The problem is known as “latent gains” and can also give rise to problems at incorporation, even when “incorporation relief” applies to roll capital gains into shares. I had over £1,000,000 of latent gains having raised significant funds to pay off my ex-wife after our divorce.

The “get out of jail card” for me was moving to Malta, because that re-based the value of my portfolio to the April 2015 values as a result of becoming non-resident for UK tax purposes. There are other ways too.

Mark Alexander - Founder of Property118

19:25 PM, 1st July 2022, About 2 years ago

Reply to the comment left by John Spring at 01/07/2022 - 15:17
Please visit my Member profile from which you can private message me. If you outline this situation in your message I will respond by privately sharing a far better solution for you.

LaLo

19:52 PM, 1st July 2022, About 2 years ago

Live now - Pay later! A lot depends on your age - live it up while you can !

Mick Roberts

8:52 AM, 2nd July 2022, About 2 years ago

We agree on most things Mark, however I do have different view to u about KEEPING the interest only forever.

Your logic about keeping money for future purchases should house prices fall etc. is spot on. I did the same & bought 18 or 19 houses in 2008 when property prices dropped by half.

U probably feel more strongly about it cause your parents struggled to pay off mortgage.

I'd say What if u can overpay without struggling? What if u can still have all your treats & holidays & cars etc. & not notice the overpayments.

If it's any consolation, I tell everyone to get interest only till they comfortable and save every penny if they still buying, and then get in a pattern of regular overpaying so u don't notice it.

I know 100's of Landlords as do u. I also have about 15 close mates who are Landlords. Who I bike with every Sunday, go Magaluf biking, skiing etc.
And those that have overpaid over the years are much better off now than those who haven't overpaid. They can buy the better bikes, don't think about booking the next holiday etc.

I've also got mates who are borrowing £ millions just as in your scenario where u better off with Inheritance Tax. And that suits them. I just despise Lenders.

Gratification postponement.
Take the bus for 10 years so u can get the taxi for 40 years.

Now again, I'm not saying it's for everyone, but it suits me. Anyway, I can't talk as I still owe a fair whack that could scare most people.
And the amount I overpay every month would scare u too ha ha -You'd be straight on the plane from wherever u r to give me the biggest bollocking.

I know the IHT planning goes against paying all debt off, but it is nice being debt free as one gets older & all that rent money not spent on mortgages.

And as Ian Narbeth says, many are caught out by the CGT trap.

Mark Alexander - Founder of Property118

9:07 AM, 2nd July 2022, About 2 years ago

Hi Mick

If you have more cash than you need, rather than paying down mortgages, why not give somebody a carer in your business by training them to do what you do.

Better still, why not buy more properties and use the extra cashflow from them to fund your 'mini-me'? That way, you can take as many holidays as you want because you've got all that extra cash and somebody back at home holding the fort for you. 20 years on and yet again you're even better off because inflation has worked its magic on the rent and the property values but the outstanding mortgage balances haven't changed.

At this point, not only have you achieved financial freedom but you're also location independent.

The weather in Malta is awesome by the way. Now off to the "Beefbar on the Beach" - look it up.

Mick Roberts

10:06 AM, 2nd July 2022, About 2 years ago

Reply to the comment left by Mark Alexander - Founder of Property118 at 02/07/2022 - 09:07
Thanks for advice Mark.

I've already took the career man on in 2017. They never as good as us unfortunately. He lasted a year. My actual Landlord tenant work isn't that bad now, got all good tenants, we just getting beaten down by imbecile Govt, MP's, Councillor's, Council etc.

Ha ha don't ask me to buy any more, I need to sell at least 4 a year to get down to my target figure in 10 years, well probably 5 a year now for 8 years. I have a running joke on Linkeldn, if anyone contacts me suggesting they can help me grow & buy more properties, I ruddy block 'em.

I don't need any more cash flow. Years ago, I'd have said more the better. However now it's time I want. I already go on as many holidays as I want each year, where I want, what hotel I want. It's nice now to not have to compromise. An don't get me wrong, I still need a certain amount of income, my mates laugh when they say Why do u want that much per week, I say We all different, u may need this, he may need that as he likes buying jewellery, holidays in Marbella etc. I need my certain amount as my biggest outgoings now are holidays & car depreciation. Many people forget about car depreciation as they get older. If one doesn't want or like nice cars, fair enough-I do.

Buying more houses is more work, regardless of who's running the houses for us. We never know what the Govt is gonna' throw at us next. And if Labour get in Ooh Baby we gonna' have a 1% charge on the value of the houses-Just like that.

I love my location, took me 14 years to get it, & a 16 months to build it, SW rear facing, sun 11 till 7, 8 bathrooms, 7 garages, pool etc.

Yes u loving it in Malta. Beefbar looks great.

Tell u what someone can do on this page for me, explain in normal Joe Bloggs Layman's terms, I can explain to me mates, the benefits of having lots of mortgage debt for IHT. Is it just the fact that u have less equity for the tax man to say We having some of that? So one has to surmise that money you've built up from not paying the debt down, tax man has that instead-Unless of course you've gave that away to family etc. & beaten the 7 year rule.

geester24

10:57 AM, 2nd July 2022, About 2 years ago

Reply to the comment left by Mick Roberts at 02/07/2022 - 08:52
Hi Mick,
Being a cyclist myself I was caught by your mention of biking. So where's your biking locale? Perhaps there should be a landlords cycling club if not for any other reason that people seem to hate both landlords and cyclists 🙂

Gary

Mick Roberts

11:18 AM, 2nd July 2022, About 2 years ago

Reply to the comment left by geester24 at 02/07/2022 - 10:57
I am the locale,
I send the message out to mates on Thurs or Fri & we meet Sunday mornings 0730ish, around Bulwell or Nuthall Island.

At moment, we doing Skeggy training as we bike there once a year, missus's drive over, hotel, restaurant etc. Come back next morning. So at moment it's road biking 50 miles this Sunday. Skeggy Sat 6 Aug.
This leads to other stuff ie. We just got back 2 weeks ago from Magaluf road biking, do it every year & 11 of us have booked for June 2023. Some lads bike all day, most of us back to the hotel for 12 midday so get holiday out of it too.

MagalufBikingSun12Jun2022
https://photos.app.goo.gl/d1Zu3Y2b9F1gg3Tw8

Then winter mainly mountain bikes. Which leads to us sometimes stopping over in Youlgreave Peak District & biking back next morning.

Ha ha yes, car drivers do hate us don't they, forgetting that most of us drive cars as well.

You're welcome if u local. I have to vet u first though ha ha, as we all close, rib each other, have right laugh & don't want any mardy bafoon's wrecking our Sundays.

geester24

12:08 PM, 2nd July 2022, About 2 years ago

Reply to the comment left by Mick Roberts at 02/07/2022 - 11:18
Nice part of the world.
You on Strava?
Am Epping Forest way so quite far. Looks like you have fun 😆

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