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UK Interest Only Mortgages
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Interest Only Mortgage

 

Borrow more pay less?

How it works

An Interest Only Mortgage is where your monthly repayments to your mortgage lender only repay the interest that is being charged on your mortgage loan.

 

However with a Repayment mortgage the amount that you repay each month will reduce both the interest and the capital that you borrowed. With an interest only mortgage the loan is re-paid in 2 separate parts - the loan and the interest. The interest is re-paid but none of the actual loan is re-paid until the end of the mortgage term.

 

An Interest Only Mortgage will cost you less - so you can borrow more. On a typical £200,000 mortgage you can cut your mortgage payment by around £4000 with an interest only mortgage. This deal sounds great, but at the end of the mortgage term your lender will still want you to pay back the money you borrowed. So if you borrowed £200,000 you will get a bill for £200,000.

 

It is therefore very important that money has been set aside to repay the original loan.

 

What are the risks?

If finances are a problem but you are keen to get on the property ladder an interest only mortgage may seem like a good idea. You must make sure that you understand the risks involved and have a clear plan as to how you will pay off your loan at the end of the mortgage term.

 

Do not rely on an increase in the price of your property to pay off the capital debt at the end of the mortgage term. Anyone who takes out an interest only mortgage without repaying capital is taking a huge risk if property prices fall, as your debt will be bigger the the value of your home.

 

So its cheaper than a repayment mortgage?

Only in the short term. In the long term your interest only mortgage will actually cost you more than if you took out a repayment mortgage at the same rate.

 

Why you ask? Well with you interest only mortgage you are not paying back any of the money you borrowed, and therefore the interest you pay each month is on the full amount.

 

With a repayment mortgage your debt is actually decreasing, and as the amount you owe your lender gets smaller, so does the amount of interest you are paying on it.

 

In the example below an interest only mortgage works out at around £50,000 more over 25 years.

 

Interest Only Mortgage versus Repayment

  Monthly Payment Cost Over 25 Years
Interest Only £458.44 £237,229

Repayment

£614.12 £182,229

 

 

Paying off your loan capital

 

It is imperative that provision is put money into a savings scheme or an ISA each month. This will build up into a lump sum which will enable you to pay off your loan at the end of the mortgage term.

 

With Profit Endowment Policies

Regulatory requirements were lifted some time ago that stated if a borrower had an interest only mortgage the bank must make sure that a saving scheme was set up by the borrower.

 

Previously interest-only mortgages were usually combined with an endowment policy designed to pay off the mortgage.

 

Interest-only mortgages were very popular during the 1980s when they were taken out with a with profit endowment policy. This also included life insurance cover. Unfortunately many homeowners believed that the endowment would not only pay off the mortgage but provide a lump sum too.

 

Many of the funds failed to deliver a profit due to poor management and there was a huge mis-selling scandal after which the endowment policy lost much of its popularity.

 

 

Should I consider an Interest Only Mortgage?

 

High prices in the South of the country mean that sometimes an interest-only mortgage can be cheaper than renting. You may not be paying off the capital but you are on the property ladder. If your house increases in value then you can sell at the end of the mortgage, pay off your loan and pocket the profit.

 

In the current financial climate where vast profit in property is not a fixed certainty it is more sensible to switch a repayment mortgage as soon as possible. You must remember if prices fall you could face repossession. Borrowers who never pay off their debt are just renting from the bank or building society rather than a landlord.

 

It is possible to switch to a part re-payment and part interest only mortgage so that some of the capital is repaid.

 

Pros of an Interest Only Mortgage

    • They are cheaper initially
      They get you onto the property ladder
      You have the opportunity to invest your money to pay of your loan capital
      If your investment exceeds its estimate, then you can pay off your mortgage early and receive a lump sum at the end of the mortgage
  •  

    Cons of an Interest Only Mortgage

    • If prices fall you could lose your home
      Your debt never get paid off until the end
      They can be a gamble - no guarantee you will have the fund to pay of the loan at the end of mortgage
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    Interest Only Mortgages - Further advice

     

    An interest Only Mortgage may be the best option for you. Before considering an Interest Only Mortgage though it is sensible to get professional financial advice.

     

    If you would like to chat to a financial advisor then we can find someone local to you who will advice you for free. We can also help by answering any questions you may have. Click on the links below for more information.

     

     

    There is no obligation with any of these services, and both are offered completely free.

     

     

    Value of Property  
    £
    (eg 135000) 
    Value of Mortgage
    £
    (eg 85000) 
    Type of Mortgage