Interest-only mortgages

Your home may be repossessed if you do not keep up repayments on your mortgage

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Interest-only mortgages: all your questions answered

This blog explains more about interest-only mortgages and gives a comprehensive overview of how they can be used and how they have been used in the past.

What is an interest-only mortgage?

A mortgage is a loan secured against your property; either the home you live in or another property you own.  You make a monthly payment to the lender for the money you have borrowed to buy your property.

With an interest-only mortgage, you only pay the interest charged by the lender each month when you make a repayment; you do not pay back any of the capital balance originally loaned to you.

This means that whilst your monthly repayments would be lower throughout the term of the mortgage, at the end, the full original amount borrowed is still owing to the lender.

Any borrower planning to take out an interest-only mortgage needs to make some form of savings or investment to build up sufficient capital alongside their mortgage.  Those funds will be required to repay the original loan to the lender at the end of the mortgage.  If there isn’t enough money to cover the original balance at the end of the mortgage term, the borrower faces having to sell the property to repay the debt.

Why choose an interest-only mortgage?

Interest-only mortgages have always been seen as a more affordable alternative to the traditional repayment mortgage.  Here are a few reasons why you might consider an interest-only mortgage:

  • If you urgently require a home but do not have the finances to make normal repayments for the first few years
  • If you plan to re-sell the property within a short period of time
  • If you are looking for an option with low initial payments

Are there any other benefits to interest-only mortgages?

As well as lower monthly payments for the first few years of the mortgage, there are a couple of other benefits to interest-only mortgages:

  • You can build your credit score while making repayments
  • You may qualify for a larger loan amount in the future if you can prove your ability to keep up repayments on your mortgage

Do interest-only mortgages come with risks?

The short answer is yes.  There are some key issues to consider before opting for an interest-only mortgage:

  • The amount you owe on your mortgage won’t go down during any fixed rate period
  • Any extra money left each month after paying a reduced mortgage repayment should be saved.  The reality however is that most people spend the extra money they have, living from day-to-day instead of having a long term strategy
  • Your home may not increase in value the way you hope it will putting a stop to plans for an early re-sale
  • “Payment shock” when you switch from paying the interest-only to covering the capital is a big risk if you don’t have the income to cover increased payments

You may consider tackling some of these risks by paying more than the minimum amount each month but you must be careful.  Not all interest-only mortgages will allow you to do this.

Lessons from historic interest-only mortgage borrowers

The popularity of interest-only mortgages during the property booms of the 1980s and 90s means that there are large numbers of home owners coming to the end of their mortgage term over the next few years.

It is thought that many don’t have a plan to pay back their loans so these borrowers will have to raise significant amounts of capital to repay the debt, most likely by selling their homes, or face repossession.

The size of the problem facing borrowers

In 2012 the rules were tightened to ensure that interest-only mortgages are no longer offered without a suitable repayment plan in place. This has reduced the numbers sold, however this was not the case historically and as such it is estimated that 2.8 million homeowners in the UK have interest-only mortgages and around 1 million do not have a plan for repayment in place.

The Financial Conduct Authority expect there to be waves of potential repossessions in 2027 and 2028 and again in 2032 based on previous peaks in the sale of interest-only deals.

An additional issue for those that do have a plan in place is that the endowment policies that many took out during the 80’s and 90’s to repay their loans have not delivered the predicted returns. So, whilst the borrowers have a plan in place it is going to leave a shortfall in the amount needed to repay the loan.

I have an interest-only mortgage and no way to pay my balance, what are my options?

As with all financial issues the sooner the extent of the problem is known and action taken the better. The good news for borrowers with interest-only mortgages is that there are options available to them.

  • Start building up the capital to repay the amount owing – putting a savings or investment vehicle in place now to build up a lump sum for the end of the mortgage is probably the most obvious option. The problem with this is likely to be one of timing. Where remaining mortgage terms are short it is unlikely that borrowers will have the available income to save the amount required to fully repay the amount owing. It can however be used in conjunction with some of the other options detailed below.
  • Switching all or part of the mortgage to a repayment mortgage – this will ensure that all future mortgage payments repay not only the interest but make a repayment towards the capital amount owing. This will mean a significant increase in monthly mortgage payments however; many borrowers may not be able to afford this.
  • Extending the term of the mortgage – with people living and working for longer, lenders have over the last decade extended the length of term that you can have a mortgage with some offering terms up to age 75 or over longer. For clients over a certain age a ‘lifetime mortgage’ may be available, this can allow the mortgage to run until the borrower’s death.  Increasing the term of the mortgage in conjunction with either switching to a repayment mortgage or setting up some form of savings vehicle gives the borrower more time to take appropriate action.
  • Reviewing existing repayment plans – it is important that existing repayment vehicles are reviewed regularly to ensure that they are on track to repay the debt. If not, then additional payments or other forms of savings can be taken out where affordable or some of the other options above are used to help reduce the shortfall.

The importance of mortgage advice

We talk at length across our website and social media channels about the value of mortgage advice but never is it as crucial as when you consider an interest-only mortgage!  They come with significant risks so you must get advice before you think about borrowing this way.

Our professional, friendly brokers have over 100 years’ experience between them and will provide clear, reliable advice tailored to your specific circumstances.  If you’re worried that you won’t be able to repay the balance on a current interest-only mortgage you have, please talk to us.

Get in touch today

We’ll talk through your circumstances and what you’re hoping to achieve.  We’ll outline any fees but don’t worry, you’ll only pay if you choose to go ahead.

Call 0117 907 0818, email contact@mortgage-style.co.uk or use our online web chat.

YOUR HOME OR PROPERTY MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.

There may be a fee for mortgage advice