Tag: interest rates

Dealing with the dangers of interest-only mortgages

Dealing with the dangers of interest-only mortgages

Interest-only mortgages are exactly what they sound like.  During the lifetime of the mortgage, you only repay the interest on the mortgage.  The principal only becomes repayable at the end of the term.  On the one hand, this keeps your monthly payments low.  On the other hand, it means you pay the maximum amount of interest because the amount owed does not go down over the term of the mortgage as it does with repayment mortgages.  It also means that there is a huge bill waiting for you at the end of the term.

Interest-only mortgages are still very much alive and kicking

These days, interest-only mortgages have just about disappeared from the residential-mortgage market.  They are still very much in use in the buy-to-let market but that is another situation.  There are, however, still a number of “legacy” interest-only mortgages at various stages of maturity and if you hold one of them, then you need to start thinking seriously about your options.

Option 1 – convert to a repayment mortgage

This may not be as easy as it sounds given that interest-only mortgages are more affordable month-to-month than repayment ones, so, you may find that the higher payments required for a repayment mortgage are out of your reach, especially if you are due to retire over the course of the term.  On the other hand, it might not be out of the question either, especially if you are going to be working for most of the term.  Although you will not have any equity in your home, if it’s value has gone up, then that will effectively act as a deposit for you and reduce the amount you need to borrow.

Option 2 – sell your home

You don’t have any equity in your home, so equity release isn’t an option.  In practical terms, you’re just renting it from the bank, while you work on getting the money together to buy it outright.  In principle, you have an advantage over renters in that you can do what you like with and in your own home.  The flip side of this, however, is that you also have the responsibility of maintaining the property.

If you can’t convert to a repayment mortgage and don’t yet have a feasible plan in place for paying off the principal at the end of the term, then it might be best to consider whether or not you really stand a decent chance of being able to do so and, even if you do, whether you’re really willing to do whatever it is you’re going to need to do to make that happen.  In other words, how much of a sacrifice are you willing to make?

Unless you are 100% sure that you can get the necessary funds together and that you’re willing to do whatever is necessary to achieve your goal, then it might be best just to grit your teeth and sell your home, even if you are in negative equity, because there’s no guarantee that the situation will get better if you wait.  In fact it might get worse.

Option 3 – increase your income so as to be able to make the repayment

There are lots of potential ways to increase your income from monetizing your home in some way (e.g. renting out a room), to starting a side-hustle, to looking at savings and investments.  Each has different advantages and disadvantages and chances of success.  If you’re going to go down this route, then it may make sense to talk with a financial adviser so that you can get an unbiased second opinion on how practical your plan is likely to be and whether there are any adjustments you could make which might improve its chances of success.

Your property may be repossessed if you do not keep up repayments on your mortgage.

Equity Release refers to home reversion plans and lifetime mortgages. To understand the features and risks, ask for a personalised illustration. 

For equity release, savings and investments we act as introducers only.


Understanding Interest Rates

Understanding Interest Rates

In the UK, interest rates have now been so low for so long that even those who are, technically, old enough to remember the double-digit inflation of the 1980s, may have forgotten what it meant in practice.  It meant that cash deposits could bring could returns for savers – but borrowing could be eye-wateringly expensive.  With Brexit on the horizon and a “no-deal” looking close to certain, now may be a good time to go over interest rates, the theory and practice.

When currencies weaken, interest rates tend to go up

The Monetary Policy Committee of the Bank of England is tasked with keeping inflation at exactly 2%, but since this is the real world, it is allowed a 1% “margin of error” either way.  If inflation falls below 1% or rises above 3%, however, the Bank of England has to write an open letter to the chancellor explaining what it intends to do about it.  If inflation falls below 1%, the BoE has two options.  It can lower interest rates (assuming there is room for it to do so) or it can implement a programme of quantitative easing.  When inflation goes up, however, the BoE’s only option is to increase interest rates.

The Brexit question

If Sterling weakens due to Brexit (or for any other reason), it will increase the cost of importing goods from overseas.  If this cost is offset by gains elsewhere, such as inbound tourism, then the net effect may be zero (or close to it), but if it is not, then either the UK will have to cease (or severely limit) its imports and/or inflation will increase and in the latter case the BoE will be forced to raise interest rates to meet its 2% target.

The only other option would be for the government to change the inflation target in some way, either by permitting inflation to go higher or by changing the means by which it is measured (such as the change from the Retail Price Index to the Consumer Price Index).  This is certainly possible, but it would be politically challenging.  Allowing inflation to rise would potentially impact everyone, including borrowers, whereas allowing interest rates to rise would benefit savers but hurt borrowers. Raising interest rates would also, at least potentially, make Sterling more attractive on the international markets, thus potentially bringing the value of the currency back up and lowering inflation naturally.  Having said that, this tactic did not work for John Major back in 1992, when the UK exited the ERM.

What this means in practice

In very blunt terms, Brexit could mean that savers finally get to see better returns on their cash deposits and borrowers start to see an increase in the cost of financing their debt.  Having said that, it is still very possible that savers will not see enough of a benefit to make it worth their while to readjust their asset allocation in favour of cash.  Borrowers, by contrast, will have no option but to swallow up the higher interest rates as they will be reflected across all lenders albeit to varying degrees.  This means that it is now critically important for borrowers to do everything in their means to pay down debt as quickly as possible and the higher the level of interest payable on the debt, the more important it becomes to pay it down.  If borrowers are unable to pay down their debt immediately, for example, if they have mortgages with long terms, then it may be worthwhile to switch to a fixed-rate product so at least they will have the security of knowing what their payments will be over the life of the product.  As always, however, individuals will need to do their own sums to see if this approach makes sense in their own situation.

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Some interesting facts about interest rates

Some interesting facts about interest rates

At a very basic level, interest rates are percentage fees levied whenever one person has use of another person’s money.  While the headline numbers can look small, they can have a very big impact so it really does pay to understand how they work.

Interest rates can be simple but they are more likely to be compound

Simple interest rates are based purely on the initial sum lent or borrowed.  For example, if you lent someone £100 and charged 1% per annum simple interest, then each year you will receive £1 in interest.  If, however, you charge 1% per annum in compound interest then the first year, you will receive £1 in interest but the second year, you will receive £1.01 in interest.  This may not seem like much of a change but as the years go by, it will add up.

That was, of course, a very simple example.  In reality, while simple interest really is simple, compound interest can be much more complicated as there can be all different kinds of ways of calculating it, which is why the annual percentage rate (APR) can come in very useful as a guideline to your financial “worst-case scenario”.

Different people (and companies) can be charged different rates for exactly the same product

If two different people (or companies) apply to exactly the same lender for exactly the same product, they can still be charged different rates for it.  This is because the lender will assess risk and reward on an individual basis.

For example, let’s say two borrowers want to buy identical houses on a new-build development.  One has a 10% deposit and is self-employed (albeit with the required level of documentation to show income) and the other has a 25% deposit and is fully employed, has been so for several years and works in a skilled and fairly secure profession.  It’s easy to understand why a lender would see the second borrower as being far lower risk and hence want to attract them with a lower interest rate.

The good news here is that being aware of this reality is a crucial first step in understanding what it means for you and hence what you need to do to manage it.  This basically entails looking at your situation as a whole and deciding where you are prepared to make compromises and where you are not.  For example, if you are currently employed but want to go self-employed, then it may be best to wait until after you have bought a property and been approved for the necessary mortgage, or, if you are already self-employed, then you may want to make sacrifices elsewhere in your life so you can build as big a deposit as you possibly can.

Interest rates are in a constant battle with inflation

If you’re a saver then the only way you can make an effective (i.e. real-world) profit from your cash deposits is by earning an interest rate which is above the rate of inflation.  If you are a borrower, then the only way you can earn a profit on the money you borrow is by generating a return which beats inflation after you have paid your lender interest on the sum which, as we have already seen, needs to make them a profit after inflation.  Whatever way you look at it, inflation is the enemy of profit whether that profit comes in the form of interest rates for savers or investment returns for anyone.  Of course, the fact that people do regularly manage to beat inflation shows that it is possible, however, it is important to keep the effects of inflation in mind when taking any financial decision, including assessing interest rates.

Your property may be repossessed if you do not keep up repayments on your mortgage.


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