At first glance, an interest-only mortgage might seem ludicrous. You make monthly repayments and when you get to the end of the term, you STILL owe the FULL amount of the property’s capital to your lender?
You might wonder why anyone would do that.
While the fact is true – you do still owe the full amount you borrowed – there are many reasons people may choose to take out interest-only mortgages.
In this blog, we explain why someone might take out an interest-only mortgage and the pros and cons of doing so.
The plus points
The property ladder can feel unclimbable to a first-time buyer – like someone has come along and greased it so that you just slip off whenever you try to get a grip. It can be tough going.
It’s an option therefore, for first-time buyers to take out an interest-only mortgage. It allows them to get on the property ladder with a lower amount to pay each month than an ordinary ‘repayment mortgage’, where you pay back the interest as well as the capital (the actual amount you borrowed).
While lower monthly repayments are attractive to first-time buyers, an interest-only mortgage can be difficult to get. Many lenders ask that you have a large deposit and that you earn over a certain amount – which can be high.
Interest-only mortgages can also work quite nicely for landlords. It gives them the option of charging the tenant more than their monthly repayments, which means they make a profit. They can then put the profit in an ISA or other investment vehicle and either pay the mortgage off at the end of the term, or sell the property and use the money they raise to repay their lender.
Whether you’re a landlord, first-time buyer or already on the property ladder, to take out an interest-only mortgage, you will need to show the lender how you plan to repay it at the end of the term – known as a repayment vehicle. This could be with a savings plan like an ISA, investments or a pension lump sum payment, for example.
This is neither a pro, nor a con but just a fact of the application process. It’s going in the ‘pro’ section because it is a sign of responsible lending. In fact, regulation brought in in 2014 (the Mortgage Market Review) has seen a full overhaul of how interest-only mortgages operate. The market is much safer for borrowers now and much more tightly regulated too – which is never a bad thing.
First and foremost – interest-only mortgages can be more risky. If you’re planning on repaying the mortgage at the end of the term with the sale of the property, you run the risk of your home selling for less than you bought it for. If this happens, you will owe more than you borrowed in the first place. Not ideal.
Interest-only mortgages are not as commonplace as they once were. We mentioned that the Mortgage Market Review had tightened up the regulation surrounding them, but since these rules were introduced, interest-only mortgages have become the exception rather than the rule, so it could be difficult to find one you want.
Owing the full amount at the end of the term can also be pretty daunting. What if something goes wrong with your repayment vehicle? What if you lose your job and therefore your pension? What if you invest it and you don’t get the pay-off you expected? These are all things you need to account for if you’re looking to take out an interest-only mortgage.
Finally, the obvious downside to an interest-only mortgage is the simple fact that you spend 25 years making monthly repayments, yet you’ll still owe the full amount at the end of the term. It can feel demoralising to say the least.
So is it for me?
Obviously as with most things in life, there are two sides of the coin. This blog will have given you an idea how an interest-only mortgage can work and why it would be of benefit to some borrowers.
If you’re thinking about taking out an interest-only mortgage, you’ll need to do your research and make sure it’s the best option for you.
And don’t forget – you can also speak to a mortgage advisor if you’re not sure. A problem shared is a problem halved after all!
Disclaimer: All information and links are correct at the time of publishing.