UK Interest Only Mortgage Calculation

Hello,

Perhaps someone can help me with a finance problem:

I need to know how UK based mortgage companies calculate the monthly
payment due for an interest only mortgage.

Has anyone investigated the following idea concerning mortgages:

Say my payment on an interest only mortgage is (approximately) =A3750,
and my payment on a repayment mortgage is =A31050[, on a =A3175k loan
with a duration of 25yrs at about 5%].

If instead of opting for the repayment mortgage, I select interest
only, and the =A3300 difference I invest in an ISA, or someother (tax
free or securish) investment vehicle, and then regularly paid from the
investment vehicle into the mortgage - how could I calculate the
relative performance of the two repayment plans.

I've spent a month trying to investigate this problem, and i'm stuck
trying to work out how mortgage company's work out their interest only
monthly due, I consistently get twice the actual amount!!

Any documentation/information/books/pointers etc... would be gratefully
received,

Graeme Newlands.

Re: UK Interest Only Mortgage Calculation

<> wrote in message
news:
> I need to know how UK based mortgage companies calculate the monthly
> payment due for an interest only mortgage.

Divide the rate they quote (not the APR) by 12. Simple!

Eg 175k at 5% is 175000*0.05/12 = £729.17 per month

> Has anyone investigated the following idea concerning mortgages:
>
> Say my payment on an interest only mortgage is (approximately) £750,
> and my payment on a repayment mortgage is £1050[, on a £175k loan
> with a duration of 25yrs at about 5%].
>
> If instead of opting for the repayment mortgage, I select interest
> only, and the £300 difference I invest in an ISA, or someother (tax
> free or securish) investment vehicle, and then regularly paid from the
> investment vehicle into the mortgage - how could I calculate the
> relative performance of the two repayment plans.

Just compare their interest rates/returns. For accuracy (to account for compounding),
annualise the rates.

If the investment interest rate/return is higher than the mortgage rate then you're
better off with the investment, otherwise you're better off with the mortgage.

To annualise the mortgage rate (to account for compounding), you need to raise the
monthly interest factor to the power of 12, and subtract 1.

Eg if the rate is 5%, then that's really a monthly rate of 0.4167%, which is a
monthly factor of 1.004167, which ^12 is 1.05117, an annualised rate of 5.117%. (This
will be different from the APR as that includes fees etc).

--
Andy

Re: UK Interest Only Mortgage Calculation

In message <>, Andy Pandy
<> writes
>Eg if the rate is 5%, then that's really a monthly rate of 0.4167%, which is a
>monthly factor of 1.004167, which ^12 is 1.05117, an annualised rate of
>5.117%. (This
>will be different from the APR as that includes fees etc).

If there were no fees and the interest was applied and paid monthly so
that there was no compounding then the APR and the annualised rate would
be 5%.

--
John Boyle

Re: UK Interest Only Mortgage Calculation

John Boyle wrote:

> In message <>, Andy Pandy
> <> writes
>>Eg if the rate is 5%, then that's really a monthly rate of 0.4167%, which
>>is a monthly factor of 1.004167, which ^12 is 1.05117, an annualised rate
>>of 5.117%. (This
>>will be different from the APR as that includes fees etc).
>
> If there were no fees and the interest was applied and paid monthly so
> that there was no compounding then the APR and the annualised rate would
> be 5%.

No. Even for an interest-only loan, a nominal annual rate of 6% which is
applied and paid as 0.5% monthly, will *not* correspond to an APR of 6%,
because paying £500 a month (on a £100k loan) costs you more than paying
£6000 once a year, because you could have diverted the £500pm from your
income stream into a deposit account (especially one of those "regular
saver" ones with the temptingly high interest rates), and then if you
withdrew the £6000 for your annual payment, you'd still have the deposit
interest left over.

You can't really say "there is no compounding" even when the balance
remains the same from month to month, because APR rules *assume* there
is compounding.

Re: UK Interest Only Mortgage Calculation

wrote:

> I need to know how UK based mortgage companies calculate the monthly
> payment due for an interest only mortgage.

You simply multiply the loan debt by the nominal annual interest rate
to get the annual interest due, and then divide by 12 to get the monthly
interest due. Truth be told, some lenders might, instead of dividing
by 12, divide by 365 and multiply by the number of days since the last
payment, but it will (near as makes no real difference) average out
the same.

> Has anyone investigated the following idea concerning mortgages:
>
> Say my payment on an interest only mortgage is (approximately) £750,
> and my payment on a repayment mortgage is £1050[, on a £175k loan
> with a duration of 25yrs at about 5%].
>
> If instead of opting for the repayment mortgage, I select interest
> only, and the £300 difference I invest in an ISA, or someother (tax
> free or securish) investment vehicle, and then regularly paid from the
> investment vehicle into the mortgage - how could I calculate the
> relative performance of the two repayment plans.

Why would you choose to make regular transfers from the investment
vehicle to the loan account? There are two possibilities: Either
the investment performs better (after tax) than the loan interest
rate, or it doesn't. In the latter case you'd be better off with
a repayment loan.

Remember that "investing in" your repayment loan is automatically
tax free, and the equivalent rate of return *is* the loan interest
rate.

You have re-discovered the endowment mortgage, which is a pairing
of an IO loan with a market investment (or actually it's a tripleting
of those two with a life insurance policy), except you've cut out the
insurance element and are opting for DIY investment instead. That's
perfectly OK provided you're happy with the risk associated with
whatever vehicle you choose. It's unlikely that cash ISAs, on the
whole, will outperform lending rates in the long term, though shares
ISAs might, if you pick them well.

> I've spent a month trying to investigate this problem, and i'm stuck
> trying to work out how mortgage company's work out their interest only
> monthly due, I consistently get twice the actual amount!!

Well, perhaps if you showed us a sample calculation which gets the
wrong answer, we can tell you where you're going wrong.

At 175k, 300 months, at 5%/12 per month, an IO loan will cost you
175k * 0.05 / 12 per month, which is about £729. A repayment loan
will cost 175k * 0.05/12 / (1 - (1+0.05/12)^-300) which is £1023.

I you were to invest £1023-£729 per month in an investment vehicle
returning 5%/12 per month (compounding monthly) tax free, for 300
months, the value of the investment after the 300th payment will
be £294 * ((1+.05/12)^300 - 1) / (0.05/12) which is (as if by magic)
exactly £175k. Well, actually it's about £80 more, but that's because
£294 is slightly exaggerated due to rounding.

Re: UK Interest Only Mortgage Calculation

In message <eB0ig.83077$>, Ronald
Raygun <> writes
>John Boyle wrote:
>
>> In message <>, Andy Pandy
>> <> writes
>>>Eg if the rate is 5%, then that's really a monthly rate of 0.4167%, which
>>>is a monthly factor of 1.004167, which ^12 is 1.05117, an annualised rate
>>>of 5.117%. (This
>>>will be different from the APR as that includes fees etc).
>>
>> If there were no fees and the interest was applied and paid monthly so
>> that there was no compounding then the APR and the annualised rate would
>> be 5%.
>You can't really say "there is no compounding" even when the balance
>remains the same from month to month, because APR rules *assume* there
>is compounding.
>
Not for periods less than a year it doesnt.
--
John Boyle

Re: UK Interest Only Mortgage Calculation

"John Boyle" <> wrote in message
news:
> In message <>, Andy Pandy
> <> writes
> >Eg if the rate is 5%, then that's really a monthly rate of 0.4167%, which is a
> >monthly factor of 1.004167, which ^12 is 1.05117, an annualised rate of
> >5.117%. (This
> >will be different from the APR as that includes fees etc).
>
> If there were no fees and the interest was applied and paid monthly so
> that there was no compounding then the APR and the annualised rate would
> be 5%.

Nope. The fact that the interest is paid monthly and so doesn't itself compound is
irrelevant. If you are comparing an ISA with a mortgage then you need to compare the
annualised mortgage rate as worked out above with the ISA's AER (if cash) or the
annual return on the investment.

--
Andy

Re: UK Interest Only Mortgage Calculation

Thank you very much for all your responses, they will probably take me
a day or two to digest!

Graeme.

Ronald Raygun wrote:
> wrote:
>
> > I need to know how UK based mortgage companies calculate the monthly
> > payment due for an interest only mortgage.
>
> You simply multiply the loan debt by the nominal annual interest rate
> to get the annual interest due, and then divide by 12 to get the monthly
> interest due. Truth be told, some lenders might, instead of dividing
> by 12, divide by 365 and multiply by the number of days since the last
> payment, but it will (near as makes no real difference) average out
> the same.
>
> > Has anyone investigated the following idea concerning mortgages:
> >
> > Say my payment on an interest only mortgage is (approximately) =A3750,
> > and my payment on a repayment mortgage is =A31050[, on a =A3175k loan
> > with a duration of 25yrs at about 5%].
> >
> > If instead of opting for the repayment mortgage, I select interest
> > only, and the =A3300 difference I invest in an ISA, or someother (tax
> > free or securish) investment vehicle, and then regularly paid from the
> > investment vehicle into the mortgage - how could I calculate the
> > relative performance of the two repayment plans.
>
> Why would you choose to make regular transfers from the investment
> vehicle to the loan account? There are two possibilities: Either
> the investment performs better (after tax) than the loan interest
> rate, or it doesn't. In the latter case you'd be better off with
> a repayment loan.
>
> Remember that "investing in" your repayment loan is automatically
> tax free, and the equivalent rate of return *is* the loan interest
> rate.
>
> You have re-discovered the endowment mortgage, which is a pairing
> of an IO loan with a market investment (or actually it's a tripleting
> of those two with a life insurance policy), except you've cut out the
> insurance element and are opting for DIY investment instead. That's
> perfectly OK provided you're happy with the risk associated with
> whatever vehicle you choose. It's unlikely that cash ISAs, on the
> whole, will outperform lending rates in the long term, though shares
> ISAs might, if you pick them well.
>
> > I've spent a month trying to investigate this problem, and i'm stuck
> > trying to work out how mortgage company's work out their interest only
> > monthly due, I consistently get twice the actual amount!!
>
> Well, perhaps if you showed us a sample calculation which gets the
> wrong answer, we can tell you where you're going wrong.
>
> At 175k, 300 months, at 5%/12 per month, an IO loan will cost you
> 175k * 0.05 / 12 per month, which is about =A3729. A repayment loan
> will cost 175k * 0.05/12 / (1 - (1+0.05/12)^-300) which is =A31023.
>
> I you were to invest =A31023-=A3729 per month in an investment vehicle
> returning 5%/12 per month (compounding monthly) tax free, for 300
> months, the value of the investment after the 300th payment will
> be =A3294 * ((1+.05/12)^300 - 1) / (0.05/12) which is (as if by magic)
> exactly =A3175k. Well, actually it's about =A380 more, but that's because
> =A3294 is slightly exaggerated due to rounding.

Re: UK Interest Only Mortgage Calculation

John Boyle wrote:

> In message <eB0ig.83077$>, Ronald
> Raygun <> writes
>>John Boyle wrote:
>>
>>> In message <>, Andy Pandy
>>> <> writes
>>>>Eg if the rate is 5%, then that's really a monthly rate of 0.4167%,
>>>>which is a monthly factor of 1.004167, which ^12 is 1.05117, an
>>>>annualised rate of 5.117%. (This
>>>>will be different from the APR as that includes fees etc).
>>>
>>> If there were no fees and the interest was applied and paid monthly so
>>> that there was no compounding then the APR and the annualised rate would
>>> be 5%.
>>You can't really say "there is no compounding" even when the balance
>>remains the same from month to month, because APR rules *assume* there
>>is compounding.
>>
> Not for periods less than a year it doesnt.

Yes it does.

Re: UK Interest Only Mortgage Calculation

In message <7icig.83297$>, Ronald
Raygun <> writes
>>>You can't really say "there is no compounding" even when the balance
>>>remains the same from month to month, because APR rules *assume* there
>>>is compounding.
>>>
>> Not for periods less than a year it doesnt.
>
>Yes it does.
>

No it doesnt.
--
John Boyle

Re: UK Interest Only Mortgage Calculation

> >>>> Andy Pandy wrote
> >>>>>Eg if the rate is 5%, then that's really a monthly rate of
> >>>>>0.4167%, which is a monthly factor of 1.004167, which
> >>>>> ^12 is 1.05117, an annualised rate of 5.117%. (This
> >>>>>will be different from the APR as that includes fees etc).
>
> >>>John Boyle wrote:
> >>>> If there were no fees and the interest was applied and
> >>>> paid monthly so that there was no compounding then
> >>>> the APR and the annualised rate would be 5%.
>
> >> "Ronald Raygun" wrote
> >>>You can't really say "there is no compounding" even
> >>>when the balance remains the same from month to month,
> >>>because APR rules *assume* there is compounding.
> >>>
> >"John Boyle" wrote
> >> Not for periods less than a year it doesnt.
> >
> "Ronald Raygun" wrote
> >Yes it does.
>
"John Boyle" wrote
> No it doesnt.

My turn: YES, it does!