Mortgage v Investing

Just a little note before the article- remember that none of this is advice, do your own research- pay a qualified financial adviser if required.

Firstly- what do I understand what each term means?

Mortgage

If you aren’t renting, this is likely to be the highest cost you will be facing, every single month. It’s not like its going away quickly either- with some mortgage terms going over 35 years now- and the average topping 30 years for the first time buyer. In general most people have a capital repayment mortgage, so when they get to the end of this term, they have £0 owed on the mortgage.

Investing

In the simplest terms, I am talking about putting money into index funds. I’ve written about these before, but they tend to offer the best returns with the least amount of risk (though, nothing is risk free). If possible, this should be done within an S&S ISA to avoid capital gains taxes etc.

So, why Mortgage v Investing?

Well, let’s talk though an example. In this, we will make the following assumptions:

  • House Price: £250,000
  • Deposit: £50,000
  • Mortgage amount: £200,000
  • Mortgage rate 2%
  • Term: 20 years

So, let’s go with the normal scenario for most people- they will go to their bank/mortgage advisor, and get a capital repayment mortgage for a initial fixed term of 2/5 years. After this period, let’s assume they fix again and again, each time for 2% fixed- just to make the figures slightly easier.

  • Monthly repayment: £1,012
  • Total repayment: £242,859
  • Interest paid: £42,859
You can only just see the cumulative effect of the repayments over 20 years

Now, what happens if instead, you only pay the interest on your mortgage?

  • Monthly repayment: £334
  • Interest paid: £80,062

Hold on, almost double the interest paid, surely this isn’t as good as paying your mortgage off as you go? Well, that all depends on what you do with the extra £678 each month that is the difference between the capital repayment and the interest only. Let’s say that you put this in an index fund for 20 years (the term we are using), with a return of 5%:

Total balance: £276,256.38

So, after you have paid off your mortgage of £200,000- you are left with £76,256.38! If you change the return from 5% to 6%, you are looking at £108,927.83

The downsides

Now, let’s talk about the downsides of this idea, as, since surely it sounds like such a good idea, why isn’t everybody doing it? Well- it’s risky. How risky? Well, that totally depends on what index fund (or any other investment) that you made. If you put it into some poni/bitcoin scam scheme, then, its likely to will end up with less/nothing at all.

Hold on- didn’t these mortgages used to exist?

They did- in a way, they were called Endowment Mortgages. They used assumptions like 7-12% growth rates, which meant as the market slowed in the 1990’s, they were going to miss these targets. There was huge mis-selling when these mortgages were arranged- since the terms were long (the same length as mortgages- at least 15 years), it took a long time before they came to be redeemed.

So, if they aren’t popular anymore, why am I talking about this?

Times have moved on- you won’t find a bank offering this type of mortgage anymore, and in fact- interest only mortgages can be hard to get as well. The biggest danger that you/the bank faces, if you take an interest only mortgage, is what happens if you just spend the extra money? You said you were going to invest, but actually, you spent it on a new car, kitchen, holidays etc. We aren’t talking- long term- about small amounts of money either, £200,000 even after inflation (let’s say 2%), is still £133,500!.

So, why does this work now? One reason- interest rates. Never have they been so low, for so long. The base rate set by the Bank of England has been below 0.5% since 2008:

This won’t be the case forever though, or will it? Nobody really knows, but the fact that banks are setting 5/10 years mortgages at 2/2.5%, means they are betting that these conditions continue for at least that time period (or they are willing to lose millions/billions of pounds). The rate has pretty much never been this low, for such a long time:

1901-2016 Bank of England Base rate

Just because it hasn’t happened before, doesn’t mean that it won’t happen in the future however- so do your own research. Take your own risks- don’t just follow somebody else.

Questions/Comments? As ever, let me know below & I’ll try and answer them as well.

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