Interest Only Mortgages
Interest only means your monthly mortgage payments will only cover the interest you owe on the loan and you pay nothing towards repaying the capital. Sometimes you will need to make arrangements to repay the capital from your other resources or set up a savings plan to cover the repayment in the future.
This type of mortgage has gained in popularity mainly due to soaring house prices and keeps your monthly payments low and gives you the flexibility to invest in a range of savings plans, some of which can have tax advantages e.g Individual Savings Accounts (ISA’s) or pensions however no repayment of capital is included in the monthly mortgage payments. There is no guarantee that your investment or savings plan will cover the mortgage repayment when it becomes due.
You will need to monitor this carefully and increase your savings early if required. If you require any more advice please do not hesitate to contact our helpful mortgage brokers for impartial advice.
The Difference Between Interest-Only and Repayment Mortgages
With a typical mortgage – aka a repayment mortgage – each monthly repayment pays back part of the total loan borrowed and the rest repays the interest charged on that borrowing. Provided all payments are made on time and in full, when the loan term comes to an end, after a pre-agreed amount of years, you will have completely paid off the entire loan balance.
With an interest-only mortgage, only the interest payable on the initial money borrowed is paid each month. Even if you make all payments on time and in full, when the loan term comes to an end, you will still owe the original mortgage balance in full as you have only repaid the interest on the loan.
Comparing Interest-Only and Repayment Mortgages
The biggest benefit of an interest-only mortgage is that the monthly repayments for the length of the term are much lower than a traditional repayment mortgage. In a typical example, consider a mortgage of £200,000 borrowed over a period of 25 years with a flat 3% interest rate:
- With a traditional repayment mortgage, your payments would be £948 each month
- With an interest-only mortgage, your repayments would be just £500 per month
This would make an interest-only mortgage far more affordable in the early stages but negatively would also leave the original balance of the mortgage outstanding at the end of the term, so in the above scenario, after 25 years you would still have a debt of £200,000 to pay, having only repaid the interest on the loan.
At the end of the term you would be required to pay off the balance in one lump-sum i.e. by an investment, property sale etc.
Qualifying for an Interest-Only Loan
Qualifying for an interest-only loan can be more challenging than being accepted for a traditional loan. This is because most lenders will want to see evidence of an exit strategy in place i.e. an approved repayment plan that demonstrates your capacity to repay the mortgage in full. In addition, it is also possible that your lender will carry out periodic checks throughout the repayment period, ensuring your exit strategy is still viable and on the right track.
Examples of acceptable repayment plans (in accordance with lenders’ individual policies) include stock market investments, ISAs, savings and guaranteed inheritance, future income or sale of property.
Repaying an Interest-Only Mortgage
In the above example, provided monthly repayments have been made in full and on time, at the end of the term, you will have successfully repaid all interest on your mortgage but will now be liable for repaying the initial £200,000 borrowed. Typical repayment options for interest-only mortgage customers at this stage include the following:
- Switch part or all of the loan to a repayment mortgage with your current loan provider so you can spread the loan balance over several years of monthly repayments at an agreed rate of interest.
- Use your savings or any other capital you have available to repay the £200,000 in full or part and refinance the balance
- Switch to a repayment mortgage or similar loan with a different provider, who may be willing to offer you a better deal than your current lender.
- Consider a bridging loan secured against your property to repay the loan in full affording you time to sell your home in the near future without incurring defaults from your current lender.
As with all property loans, there are various advantages and disadvantages to consider with interest-only mortgages. Before submitting your application, we strongly suggest consulting an independent broker to discuss the available options and choose your ideal mortgage type.
For more information or to discuss your requirements in more detail, please contact a member of the team at UK Property Finance anytime.