The cost of remortgaging calculated

Extending mortgage term and interest-only deals offer short-term solutions – but the catch can cost you thousands in the long run.

• The average fixed-rate mortgage holder with a £165,000 outstanding balance could shave £274 off monthly repayments by extending mortgage term from 20 years to 40 years, assuming 6% interest.
• But doing so would inflate the total cost of the loan from £283,707 to £435,769. 
• Switching to interest-only mortgage deal could save £357 on a £165,000 outstanding loan over 20 years.
• But you’d need to pay remaining mortgage balance at the end of your mortgage term.

Uncertainty over how high interest rates will go to combat stubbornly high inflation has resulted in an increase in mortgage rates, with the average rate for a two-year fixed-rate mortgage at 6.3%, while the average five-year deal now stands at 5.91%*.

interactive investor calculates that the average mortgage holder with £165,000 outstanding balance going on to a mortgage deal fixed at 6% from 2% faces an additional monthly cost burden of £347, based on a 20-year mortgage term.

There are more than 700,000 households with a fixed-rate mortgage deal set to expire in the second half of this year, according to official figures - most of which were fixed at 2% or below.

A host of banks and building societies have pledged to offer more flexibility to struggling mortgage-holders as rates soar as part of a new ‘Mortgage Charter’ launched by the Treasury. This could mean extending their term to reduce their payments or offering a switch to interest-only payments.

But new interactive investor research lays bare the long-term cost of these solutions.

Cost of remortgaging based on £165,000 outstanding debt and 6% interest rate

Source: interactive investor. These are for illustrative purposes only and should not be taken as advice.

Cost of remortgaging based on £300,000 outstanding debt and 6% interest rate

Source: interactive investor. These are illustrations and should not be taken as advice.

Extending the mortgage term 

Among the options to reduce the monthly repayment burden is to extend the mortgage term. Paying off your mortgage over a longer period means monthly repayments are cheaper.

ii calculates that someone seeking to remortgage their home with an outstanding balance of £165,000 could reduce their monthly repayments by £274 to £908 (from £1,182), or £3,291 a year, by extending their mortgage term from 20 years to 40 years. But doing so would inflate the total cost of the loan from £283,707 to £435,769, assuming 6% interest.

Even extending the loan by five years from 20 to 25 would reduce monthly repayments by £119 (£1,428 a year), adding £35,222 to the total cost of the loan which swells to £318,929.

The monthly savings are greater at a higher level of borrowing. A homeowner with a £300,000 mortgage balance seeking to refinance could reduce their monthly repayments by £499 to £1,651 (£5,984 yearly) when extending their mortgage term by 20 years (from 20 to 40). However, the total cost of the loan would jump from £515,830 to £792,308 – an extra £276,478 in interest costs.

Increasing the mortgage term by five years could shave £216 off monthly repayments to £1,933 but would mean an extra £64,041 in interest costs (to £279,871).

Switching to an interest-only mortgage

Moving to an interest-only mortgage can also keep monthly repayments affordable. With an interest-only mortgage, your monthly payments only cover the interest charged on your loan. The amount you have to pay out each month is lower as a result, but you must pay off the loan in full at the end of the loan term.

interactive investor calculates that a homeowner with an outstanding balance of £165,000 on a 20-year mortgage deal could save £357 (from £1,182 to £825) on monthly repayment costs, assuming a 6% interest rate. But the higher the mortgage term, the lower the monthly savings from £238 over a 25-year mortgage term to £83 over 40 years.

Similarly, someone with an outstanding mortgage balance of £300,000 on 20-year term could see their monthly repayment burden cut by £649 to £1,500, again assuming a 6% interest rate. The monthly repayment cost savings falls to £433 for those on a 25-year deal and £151 for those on a 40-year deal.

Crucially, interest-only mortgage holders are required to repay the full mortgage amount in one lump sum at the end of the mortgage or when you sell the property.

Commenting, Myron Jobson, Senior Personal Finance Analyst at interactive investor, says: “The mortgage affordability crisis has cast a dark shadow over those seeking to remortgage their homes, leaving a trail of challenges in its wake. This financial strain weighs heavily on homeowners already struggling to battle the inflationary beast in other areas of expenditure such as food bills.

“Our research shows that the popular options offering short-term relief on the monthly mortgage repayment burden come at a considerable cost over the long term.

“Those able to extend their mortgage term from 20 to 40 years could shave almost £500 off their monthly repayment bill based on a £300,000 mortgage balance, but face having to fork out £276,478 extra in interest costs.

“Moving to an interest-only mortgage helps keep monthly mortgage repayments affordable. A homeowner with £300,000 left to pay on a 20-year mortgage deal could see a £649 a month reduction to their repayment burden. However, the quid pro quo is you will be required to repay the remaining mortgage balance in one fell swoop, which could leave some scrambling. You’d also pay more interest overall compared to a repayment mortgage because the amount you pay in interest doesn’t decrease over the term.

“It is a difficult time for the 700,000 households with fixed-rate mortgage deals set to expire in the second half of this year – the majority of which were fixed at 2% or less. But it is important that those seeking to reduce their mortgage repayment burden fully understand the short- and long-term implications of the different options.

“If you haven’t already done so, it is a good idea to see if there is any more wiggle room in your budget to foot heightened mortgage costs. It is worth consulting a mortgage adviser to explore your options.”