9.5 Case 2: The Early Repayment Term —— More Chicanery
We have seen in Section 9.3 above how the Case 2 Repayment Mortgage over 20 years was misrepresented. For comparison with the possible 18 year Early Repayment Period for the Endowment Mortgage (if the assumed growth rate is achieved) we will now assess the true cost associated with an 18 year Repayment Mortgage.
Our Repayments on a £40,000 Mortgage loan borrowed over 18 years @ 11.85% p.a. are computed using the Uniform Series Formula (F5).
Our Gross Yearly Payments to First National are therefore £5,468.48.
In order to provide Life Cover, to pay the Mortgage Loan in the event of the death of either Mortgager, First National required a Life Cover Premium Payment to Irish Life of £168.00 / year.
Our Gross Cash Flow Out is therefore £5,636.48 / year.
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The entire Annuity Repayment process over the 18 year loan period is as tabulated in Columns C and D of Analysis Table 6 below. (Analysis Table 6 is also reproduced in Appendix 9/1.)
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The Interest applicable for Tax Relief for each year is tabulated in Column E of Analysis Table 6.
The Tax Relief on Interest (in this case 52% p.a.) for each year is as tabulated in Column F of Analysis Table 6.
Our Tax Relief on Premium is £10.92 / year; this is tabulated in Column G.
The entire Cash Flows applicable to our 18 Year Repayment Mortgage for Case 2 are as tabulated in Analysis Table 6.
(Note! It will be easier to follow the process of analysis if you print the Table below, separately.)
The Net Cash Flow Out for each year is as tabulated in Column H of Analysis Table 6.
Analysis Table 6
Note! Print the Table separately. The Table is not included when printing the Chapter.
We now know our Net Outlay (i.e. our Net Cash Flow Out) for each year.
Our investment is such that we will repay a £40,000 Mortgage over 18 years at an interest rate of 11.85% p.a.
The Final Value FV of this investment is:
FV = £40,000 (1.1185)18 = £300,267.12
We want to compute the Equivalent Annual Cost of repaying our Mortgage loan, so we must first compute the Internal Rate of Return on our Net Annual Outlays.
Again, refer to Example 5.8 in Section 5.3 for a refresh on the Mode of Analysis.
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Let the Internal Rate of Return = x% p.a.
We want to compute the value of the Internal Rate of Return, x% p.a., such that: when we invest Σpv (the Sum of the present values of our Net Annual Outlays) at x% p.a. over 18 years, this will yield a Final Value of £300,267.12.
(Σpv)(1+x)18 = FV = £300,267.12
The Iteration Process, by which the Internal Rate of Return (x% p.a.) is computed, is as tabulated in Analysis Table 6. The Net Cash Flow Out for each year is shown in Column H of Analysis Table 6. The present values (pv) and their resultant Final Value (FV), from the successive trial values of the Internal Rate of Return (x% p.a.), are shown in Columns I, J, and K of Analysis Table 6, Column K providing the solution of x%.
The Internal Rate of Return computes at 14.641% p.a.
i.e. Σpv invested at 14.641% p.a. over 18 years yields £300,267.12
i.e. £25,668.24 invested at 14.641% p.a. over 18 years yields £300,272.44
i.e. £25,668.24 (1.14641)18 = £300,272.44
We now know the Internal Rate of Return (IRR) on our 18 Year Repayment Mortgage investment is 14.641% p.a.
We know that the Final Value (FV) of our investment is £300,267.12.
We can therefore compute the Equivalent Annual Cost (EAC) of our investment using the Uniform Series Formula (F4).
So, for an Equivalent Net Monthly Cost of £342.44, our Mortgage Loan of £40,000 @ 11.85 % p.a. interest would be repaid in 18 years by choosing a Repayment Mortgage. Again, we see the net result of the misrepresentation by Irish Life / First National in their using the Arithmetic Average to compute the Net Monthly Outlay.
By choosing an 18 Year Repayment Mortgage our loan of £40,000 @ 11.85 % p.a. would be repaid in 18 years, WITH CERTAINTY, for a Net Outlay of £342.44 per month. —— This corresponds to an Internal Rate of Return of 14.641 % p.a. on our investment.
By choosing a 20 Year Endowment Mortgage our loan of £40,000 @ 11.85 % p.a. would be repaid in 18 years, IF THE ASSUMED GROWTH RATE IS ACHIEVED, for a Net Outlay of £341.23 per month. —— This corresponds to an Internal Rate of Return (CONDITIONAL on the assumed growth rate being achieved) of 14.675 % p.a. on our investment.
Note! The IRR for the Endowment Mortgage is computed using the Uniform Series Formula (F3) directly, in an iterative process, as was done in Section 9.2.
It can be seen from the above that no Risk Premium differential exists that would justify the choice of the Endowment Mortgage in preference to the Repayment Mortgage on the basis of the 18 Year Early Repayment Term.
Yet, (again by the financial chicanery of using the Arithmetic Average and not the Weighted Average) Irish Life / First National were able to create the illusion of a Risk Premium differential: by showing that for a Net Outlay of £341.23 per month the Mortgage Loan could be repaid in 18 years (based on the assumed growth rate being achieved) choosing the Endowment Mortgage, while also showing that, by choosing the Repayment Mortgage, it would take 20 years with a Net Outlay of £346.71 per month to repay the Mortgage Loan.
Again, a GROSS MISREPRESENTATION of the facts.
It is clear from the foregoing sections of this Chapter that the Mortgage Quotation Comparison presentation by Irish Life / First National provides the Lending Institution (in this case, First National) presenting the Mortgage Options with overwhelming ammunition, in the form of a very convincing ‘objective’ Financial Analysis Comparison, that enables their representor / advisor to use both this ‘objective’ Financial Analysis Comparison and his own purpotive ‘expert advice’ supported by this ‘objective’ analysis, to dissuade the borrower / investor from choosing a Repayment Mortgage.