Interest Rate Example

A housebuyer needs a £7,500 mortgage which is offered to him at 12.5%, or at 8.8% on an option mortgage. The buyer's total income is £30,000 a year. A married man, he has a dependent relative, so his personal allowances are £2,145 + £100 = £2,245. He contributes 6% (£216) of income to a company pension plan. Net taxable income is thus £539. Before making the house purchase he will be liable to tax at 30% of £539, which is £161.70

If he accepted a normal repayment mortgage his interest payments in the first year would be 12.5% of £7,500, which is £937.50. He would be entitled to tax relief on this sum. But since this exceeds his taxable income the benefit he derives from it is limited to the amount of tax he hitherto paid, namely £161.70. Thus, the net cost of paying the interest is £937.50 less £161.70, which is £775.80.

An option mortgage, on the other hand, will cost him in the first year in interest only 8.8% of £7,500, which is £651.20, a saving of £124.60 in the year.

It pays to take an option mortgage where a borrower's income is such that, after deducting the allowances and the first year's total mortgage interest at normal interest rates, the remaining taxable income is nil.

An option mortgage having been taken it is not, under present legislation, permitted to change to a normal mortgage for a period of one year, so you should consider the likely changes in your taxable income in that year before committing yourself to an option mortgage. Should your income rise to a point where tax at higher rates is payable, an option mortgage will be most disadvantageous.

Changes In Interest Rates

Since mortgage rates go up and down from time to time, albeit less frequently than banks' base rates, one would expect that every borrower would be repeatedly having to change the amount of his monthly repayment. Whilst it is true that this can occur, especially with violent changes in interest rates, in many cases frequent alterations in the amounts of the repayments can be avoided.

When rates rise by a comparatively small step many borrowers are given the option of either appropriately increasing their repayments or of extending the term of the loan. It will readily be comprehended that... see: Changes In Interest Rates

Personal And Business Finance 2018

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