Our Comprehensive Guide To Interest-only Mortgages

Len Burgess[1]

Len Burgess

Money Savings Advice guide to interest only mortgages

An interest-only mortgage isn’t the most common type. In fact, if you’re buying a home that you plan to live in yourself, it’s very unlikely that an interest-only mortgage is a right option for you. Interest-only mortgages are more suited to buy-to-let situations.

What Is an Interest-Only Mortgage?

An interest-only mortgage is a type of mortgage where your monthly repayments only cover the cost of interest. At the end of your mortgage term, you still owe the original amount that you borrowed, and must make arrangements to repay it.

Designed for people going down the buy-to-let route, an interest-only mortgage has smaller monthly payments than your repayment mortgage alternative. In return, you won’t chip away at your outstanding capital.

With an interest-only mortgage, you won’t be reducing your outstanding capital. With a mortgage likely to be the biggest debt you’ll ever have, finding the right way type of mortgage is of utmost importance.

Read on to learn more about interest-only mortgages and what they mean for your property.

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What Is An Interest-only Mortgage?

A mortgage is, simply, a large loan that’s secured against the value of your property. For as long as you keep up with your repayments, you’re in control of what happens to the property. If you start to miss your mortgage repayments, the property could be repossessed.

An interest-only mortgage is one borrowing option and is certainly not the most popular, but could suit your needs if you’re purchasing a buy-to-let property.

With an interest-only mortgage, your monthly repayments are as low as they can possibly be. In return, you won’t chip away at any of your outstanding capital. You’re paying just what’s required to keep on top of interest charges, without actually reducing your debt.

When you reach the end of your interest-only loan term, you will owe just as much as you originally borrowed.

Examples of monthly repayments:

Mortgage Type Mortgage amount/interest rate Monthly Repayment Amount owed at the end of the term (25years) Total to repay
Repayment £130,00 at 3.5% £651 £0 £195,311
Interest Only £130,000 at 3.5% £380 £130,000 £243,853

Numbers compiled by Money Savings Advice

You can see that an interest-only mortgage might save you money on monthly repayments, but after 25 years, you still owe the full amount, and you’ll end up paying almost £50,000 more than if you’d gone with a repayment mortgage from the start.

Unless you’ve taken out an interest-only mortgage for a specific reason, it always makes sense to opt for a repayment mortgage.

Paying Back An Interest-only Mortgage

At the end of your loan term, it’s up to you to have a plan for paying back what you owe. One option is to sell the property, using the money you make to pay back your mortgage capital. If house prices have risen during your mortgage term, you may easily make a profit to pay back what you’ve owed and to buy another property outright.

If you’ve been earning rental income for the duration of your loan term, you may have set the spare money aside to clear your mortgage capital. This is another way to pay back what you owe on an interest-only mortgage.

Some people choose to use a repayment vehicle. Simply, this is an investment that you’ve been using to build up money elsewhere. You may have held money in a stocks and shares ISA or planned to clear the mortgage with a lump-sum pension payment on retirement.

In some cases, people choose to take out another mortgage when they get to the end of their term. You might move on to a repayment mortgage so that you can start repaying your owed capital.

Ideally, on an interest-only mortgage, you’ll make overpayments through the mortgage term. Overpayments will reduce your outstanding capital and your monthly interest charges. Essentially, you’ll treat your interest-only mortgage like a repayment mortgage with extra flexibility.

An interest-only mortgage is a risk. Many people with these mortgages are at the mercy of their investments, or property market fluctuations. You need to make sure that you can pay back your debt once your mortgage term comes to an end.

Struggling With Mortgage Repayments

With mortgage debts typically being six-figure sums, they’re big debts to stay in control of. Circumstances change, and your mortgage term could be upwards of 25 years. A typical mortgage could see someone through some huge life changes like marriage, divorce, raising a family or perhaps through illness or bereavement. Nobody can truly predict what lies ahead, and with interest-only mortgages, the stakes are particularly high.

If you can’t keep up with your mortgage repayments, you could risk losing your home. It’s very important to take control if you notice that you’re struggling financially. If you have an interest-only mortgage, you must be prepared for your property to be repossessed. If you’re struggling with the monthly repayments, can you really afford to pay back the outstanding capital?

Since interest-only mortgages stay at the same level through your mortgage term, it’s vital that you have a solid plan from the start. If you’re struggling with repayments, there are fewer ways that your mortgage lender can support you.

You’re already making the smallest possible payment, only covering loan interest. Lenders can’t find ways to reduce your mortgage payments even more. One option is to take a payment break, helping you to get back on track, though the interest will still mount up and need to be paid back later.

As with any type of mortgage, it’s important not to overstretch yourself. Consider what monthly payments you can realistically afford, and always keep in mind the very large debt that you’ll be left with at the end of your mortgage term.

Interest-only mortgages can be very tempting because of the lower monthly payments, but they’re not actually cheaper than any other mortgage option.

Mortgage Repayment Terms

In most cases, mortgages last between 25-35 years. With an interest-only mortgage, this means decades of just paying interest on the money that you’ve borrowed.

At the end of your interest-only mortgage term, it’s time to pay the capital you owe. Until the outstanding capital has been paid off, the property isn’t yours to keep. At all times, repossession is a very real risk.

A plan for the future is important. If you can’t find another way to clear your mortgage capital, you’ll likely have to give up the property. Whether you sell it yourself to clear the debt or have it repossessed, the property you’ve owned cannot be yours if you can’t pay back everything you owe.

Lenders can’t afford to take risks with such large amounts of money. If you start falling behind on your mortgage repayments, you’ll find that lenders act quickly. You’ll be chased for what you owe, and you’ll need to work with your mortgage provider to make sure that you don’t lose your home.

Finding An Interest-only Mortgage

Interest-only mortgages are not the most common type. In fact, it’s getting more and more difficult to find these mortgage options. Lenders are cautious since they know that they’re not getting their capital back. When a lender must wait more than a quarter of a century to see if you can repay your debt, they’re rightfully not going to take chances.

Historically, interest-only mortgages have caused problems for lenders. Many people reach the end of their term with no way to pay back what they owe, which has meant that it’s become harder than ever to borrow on an interest-only basis.

If you want to apply for an interest-only mortgage, you’ll need to be ready to fight for it. Getting an interest-only mortgage isn’t easy, and you’ll need a good deposit to hold sway.

You’ll also have to convince the lender that you’ve got a plan for the future, and aren’t choosing an interest-only mortgage just for the lower monthly payments.

How Can Money Savings Advice Help You With A Mortgage?

Here at Money Savings Advice, we have partnered with some of the UK’s leading mortgage brokers. They have already helped thousands of people get the best mortgage deal and they can do the same for you.

Choosing an independent adviser means they won’t recommend a mortgage unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.

If you would like to speak to one of these brokers who can provide you with a ‘whole market quote’ then click on the below and answer the very simple questions.

Money Savings Advice Author Len Burgess

Len Burgess

Len Burgess is a professional financial writer who over the last five years has written hundreds of articles for all financial sectors. Len founded Money Savings Advice with the aim of helping consumers navigate their way around the financial world by providing easy to understand financial information and matching consumers with the best financial advisor based on their personal information.

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