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What are Interest-Only Mortgages?
There are currently two different ways to pay your mortgage payments – interest only or repayment.
As the term implies, you are only paying the interest part of a mortgage loan and you don’t have to repay the amount you’ve borrowed until the end of your mortgage term, unlike repayment mortgages where the loan will be cleared at the end of the term.
Read on to find out if an interest-only mortgage option is right for you.
What is an interest only mortgage and how do they work?
As you are only paying the interest part of your mortgage throughout the term with an interest only mortgage, the capital you borrowed remains outstanding at the end of the term unless you have another way to clear the debt in full.
A ‘repayment vehicle(s)’ is required to pay off the total amount borrowed at the end of your mortgage term.
Interest only mortgages might be attractive to buyers who wish increase their cash flow or to invest the money elsewhere or perhaps buy-to-let landlords who wishes to save the rental income to pay off the capital loan. First time buyers may chose this option to ease their outgoings till their income eventually rises as they gain more experience in the workforce a few years down the line (although lenders offering is niche for first time buyers).
Interest only lending has decreased since the financial crisis in 2008 as prior to this customers were not required to show lenders how the debt would be repaid and they found after the credit crunch, a proportion of interest only customers struggled to find a way to repay the capital they borrowed. There are now increasing numbers of lenders willing to bring back interest only lending but with much stricter lending criteria’s and requirements.
Ways of repaying an interest-only mortgage:
You must be able to show lenders how you can repay the outstanding mortgage at the end of the term and can’t rely on the promise of windfall such a bonus or an inheritance.
Lenders will assess whether a client’s chosen repayment vehicle is likely to pay off the capital borrowed at the end of the mortgage term and make a decision on whether to lend. They will also check at least once during your mortgage term to ensure your repayment plan is performing as expected to enable you to repay the loan at the end of term.
Examples of repayment vehicles:
– Cash saved in an ISA or savings account
– Endowment policies (regular savings plans)
– Stocks and shares ISAs
– Investment funds
– Other properties or assets
– Selling the property to pay back what you owe to the lender
A suggestion could be for someone who wishes to use an interest only mortgage is to make overpayments each year (usually 10% of the outstanding loan amount is free from early repayment charges). This mean if your cash flow or interest rates goes up or down, you can adjust your overpayment amount to suit your needs and it will decrease your risk.
- Lower monthly payments as you are only paying the interest of the loan.
- Increases cash flow to invest and grow wealth.
- More flexibility to choose where your money goes.
- Can use the extra money to make home improvements which could raise the property value.
- Interest only could cost more in interest over the term, as you are charged interested on the whole amount borrowed whereas with repayment mortgages, the capital decreases over the term which means interest paid should also decrease.
- Not as many lenders offering interest only products due to the risks involved.
- A plan needs to be set in place to repay the capital at the end of the term as there is no guarantee selling the property could pay it off as the property market could become unpredictable and the same applies for investments where funds may be less than you were expecting.
- Time consuming as you have to keep track of your mortgage and investments.
- More risky and complicated.
There are many factors to consider when deciding whether to use an interest only mortgage and it will depend on your personal and financial situation and your attitude to risk. If you wish to seek further advice to be able to decide whether an interest only mortgage is suitable for you, please do not hesitate to contact us.