Managing my money
Managing my money

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Managing my money

6.2.4 Remortgaging – a few sums

Activity 2

For the purpose of this activity let’s keep things simple by considering an interest-only mortgage – the sums for a repayment mortgage will be a bit different but will follow the same principle.

Assume the fixed rate deal on a 25-year interest-only mortgage of £100,000 ends in three years.

  • Currently the Barnett household is on a fixed rate deal at 5% p.a. If they repay now, the lender will charge an upfront six-month interest penalty.
  • They have savings earning 2% p.a. net interest, which could cover this cost, and another lender has offered them a three-year mortgage at 3% p.a. and will cover all the other costs of remortgaging.

Should the Barnetts pay the penalty and remortgage?

Discussion

The calculation goes like this.

The six-month penalty costs the Barnetts 2.5% = (5% for half a year), which is £2500 = (2.5% of £100,000).

If they keep the £2500 invested at 2% for three years, leaving the interest in the account, this will total £2,653 at the end of the three years. This is because the interest would be compounded (you learned about compounding in Week 4).

The calculation is:

(£2500 × 1.02 × 1.02 × 1.02) = £2653

The annual savings with the new lender are:

5% - 3% = 2%.

For each year, the household would save £2000 = (£100,000 × 2%), totalling savings of £6000 over three years.

So, even if the Barnetts do not invest the annual sum saved, the minimum benefit from remortgaging is £6000 - £2653 = £3347, implying that the financially capable household should remortgage.

Figure 6
MMM_1

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