Are we fooling oursleves with interest-only loans?

Over the last ten years or so more and more of us have been switching our home loans to interest-only, where all we do is service the loan every month by paying interest. In some respects we’re renting the property since we are not repaying the money we borrowed to ‘buy’ it and we are effectively gambling on the fact that increasing capital values will give us a bit of equity when we come to sell. And of course the upside in the short term is that our monthly home loan bills are smaller. At a time when money is tight generally this can be a great help.

The facility to repay a mortgage on an interest-only basis has helped tens of thousands get their feet on the first rung of the housing ladder where otherwise it would have been too expensive to do so – and allowed others to trade up during the boom years. Not that this is always a good thing with hindsight since there is no question that this in part fuelled the ridiculous rise in house prices we have seen over the last couple of decades.

Now a new report from the Intermediary Mortgage Lenders Association suggests that this method of repaying a loan – or not repaying the loan as the case may be – could become obsolete if new Financial Services Authority rules are implemented.

The FSA is concerned that people who take on interest-only mortgages are in effect taking on larger mortgages then they can realistically afford to repay and that extra checks on affordability at the point or purchase will make sure that new borrowers will only take on debt that is repayable. Critics of these new rules argue that they will make it more difficult for lenders to justify arranging new loans on an interest-only basis and that by default we will all end up with repayment mortgages going forward – increasing our monthly outgoings but ensuring that we repay our debt as we go along.

The important thing to remember if you are arranging your mortgage on an interest-only basis, or indeed have already done so, is that at some point you will need to convert it to repayment, meaning that your mortgage payment period is likely to be much longer than you originally considered – unless you are able to cope with a big jump in monthly payments when you switch to repayment.

It could be, of course, that you are happy to continue with an interest-only loan because you can show that you have some money coming to you to repay your loan at some point in the future – from other savings or from an inheritance, or perhaps from the sale of an interest you have in a company you run. If that is the case then even if the new rules do come into force it is likely that lenders will continue to offer interest only mortgages in these circumstances

Avoid the high cost of borrowing

Here’s a quick trawl round the relative merits of various forms of borrowing as Christmas approaches fast and your wallet’s not as full as you thought it was! You need to check out how much you will have to pay for the money you borrow. So here’s the low down on the various types of borrowing around, and how much each one is likely to cost you.

Overdraft

Very cheap when compared to a loan or credit card but only if you ask the bank before you take their money. If you go into the red you are likely to get hit with a bundle of charges. And if you do please remember one thing. There’s no point going on the phone to the bank screaming blue murder and demanding your money back. We can argue the wrongs and wrongs of excessive bank charges until we’re blue in the face but the chances are that the Bank’s terms and conditions will allow them to charge you. If you want your charges back then be nice! “I know I should have told you I needed an overdraft and I’m sorry but could you please refund some of the charges you have taken from my account?” is likely to get a more favourable response then “Give me my money back you useless bastard”!

Personal Loan

Useful for bigger purchases. The best place to start is probably your own bank although these days you can pick up a loan in minutes on line at good rates if you have a good credit history.. Remember to ask whether the interest rate you are being offered is fixed or variable with a fixed rate your payments won’t change if interest rates rise) and what kind of discount you will be entitled to if you pay your loan off early.

Credit Cards

The important thing in choosing a card is basically the interest rate you will be charged. You should be able to pick up a card with a 0% rate to begin. Once you come to the end of the zero rate period then it’s time to move on and find someone else that will give you money for nothing.

The other important thing to think about is when you start to get charged for purchases. Some cards will give you up to 56 days grace before charging interest. With others you will start paying from day one so they should be avoided where at all possible.

Also check out what order your debt is cleared. With some cards the cheaper debt goes first so that the most expensive borrowings (usually for cash advances) will hover over your head longest and cost you most!

Store Cards

Try to avoid these boys as much as you can. High rates of interest and inflexible terms make them unsuitable for most people – unless you can use them to pick up a discount in a specific shop and you can then afford to pay it off straight away before interest charges kick in. Interest rates can be around 30% APR – incredible when you think that base rates are down at 0.5% at the moment. This means that if you owe £2000 for 12 months you will pay around £520 in interest alone. Not a good idea! Loans and overdrafts and even most Credit Cards are cheaper.

Lower inflation doesn’t mean no inflation

So inflation, at least as measured by the Retail Price Index, is down to 4% today. Do you see much evidence of that as you trawl the supermarket shelf for bargains? You have to wonder with how many of the price increases we have seen recently have been down to the rising costs of raw materials and how many have been down to retailers looking to sneak in a few margin enhancing increases! More of the latter than the former methinks.

Retailers tell us that inflation has fallen because they have been reducing prices but there’s not much evidence of that at Supermarket tills. And it’s interesting that the inflation fall comes a day or so after retailers reported worse than expected sales figures for the month, although there is a thought that this could be due to the way Easter falls this year rather than the fact that we’re all spending less. If it’s not does it mean that consumers are finally starting to say enough is enough?

And of course the big thing for consumers is that although inflation is lower now than it was a month ago it’s still positive and at 4% it’s higher than anyone would like at this stage of a fragile recovery.

At the same time as retailers may be passing on larger increases than they need to there are criticisms that they are trying to fob us off with ‘bargains’ that we don’t really need and, worse still, will never use. Many consumers groups are now pressing retailers to rethink the two-for-one offers (and their little siblings the three for the price of two or buy one get one half price) that are filling supermarket shelves at the moment and replace them with an across the board price reduction. Many of us, they argue, end up buying more than we need and may waste an average of around £500 per annum buying food ‘bargains’ that we end up throwing out after their sell by dates.

So while you can’t do much as an individual consumer to reduce the headline rate of inflation you can at least make sure that you’re only buying ‘bargains’ that are real bargains. And tell us here at Moneysucks when you think there are shops out there that are trying to pull the wool over your eyes!