Rent or buy? The challenge of access to housing
Rent or buy? The challenge of access to housing

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Rent or buy? The challenge of access to housing

3.7 Other ways to cut mortgage costs

In the activity below, you will again use the Mortgage calculator to explore other ways to reduce monthly mortgage payments.

Activity 10 Varying length of mortgages

Timing: Allow about 15 minutes
  1. In Activity 8, you saw that Meiling was thinking about Mortgage 2 which would allow her to borrow the £100,000 she needs at an APR of 3.70% over a 25 year term. If Meiling were able to get a mortgage at 3.70% APR but over 30 years instead of 25, use the Mortgage calculator [Tip: hold Ctrl and click a link to open it in a new tab. (Hide tip)]   to help you explain the effect this would have on her monthly repayments.
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Discussion

Your entries in the Mortgage calculator should look like this:

Table 3 Inputting information for Meiling’s 30-year Mortgage 2 quote

Amount to borrow 1000,000.00
Term (years) 30
Interest rate (APR) 3.70%

Which gives the following answers.

Table 4 Meiling’s quote for a 30-year Mortgage 2

Monthly payments Total repaid
Repayment mortgage 456.15 164,214.00
Interest-only mortgage 302.78 209,000.80

Looking back to Activity 8, with a 25-year term for her repayment mortgage, Meiling would have to pay £508.09 a month for Mortgage 2. Extending the term to 30 years, reduces the monthly payments to £456.82. However, because she would have the loan for longer, interest is charged for longer so the total repaid would be higher at £164,456.16 compared with £152,427.88 for the 25-year mortgage. (The APR is the same for both loans because it reflects not just the total paid but also the timing of each payment, with more distant payments worth less.) So another way of reducing her monthly payments would be for Meiling to look for a mortgage with a longer term.

  1. Meiling is surprised to see that the monthly payments for a 30-year interest-only mortgage at 3.70% APR are so cheap. Explain why this observation may be misleading.
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Discussion

The Mortgage calculator shows that, if Meiling borrowed £100,000 at 3.70% APR over 30 years on an interest-only basis, the monthly payments would be much lower at £303.22. However, as you saw in Section 3.1 above, at the end of 30 years she would still owe £100,000. If she sold the house to pay the £100,000 back, she might have nowhere to live. Most likely, she will need to save regularly over the 30 years to build up enough money to pay off the loan and this will increase the amount she has to find each month to cover her housing costs. Also note that the interest-only loan is much more expensive in the long run – the total she would have to pay is over £209,000. Because there is no reduction in the principal owed as the years go by, the amount of interest she would pay is much higher.

DB125_1

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