6.2.4 Remortgaging – a few sums
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?
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.