With the recent ups and downs of mortgage rates, most homeowners are feeling the pinch. Continuous inflation hikes have ramped up the cost-of-living crises and pushed mortgages through the roof (no pun intended) so it’s no wonder we’re feeling strapped for cash.
Mortgage rates really have taken the brunt of inflation hikes, which has led many homeowners to question whether they can keep up with their current repayments. Current prices on variable and tracker mortgages and those coming to the end of fixed-rate deals have shown increased interest in interest-only mortgages, a product that has soared in popularity by trying to make money stretch a little further until base rates finally decline.
As of late, searches for interest-only mortgages have risen by 53%*, suggesting that borrowers are looking for ways to reduce their monthly costs in the short term before switching back to capital repayment mortgages. Interest-only mortgages are not something that we promote long-term, but it could just be the money saver you need right now until we return to some sort of normality.
What Are Interest-Only Mortgages?
Interest-only mortgages are pretty much as they sound, a loan taken against your property whereby you only back the interest for a certain period, typically the first 5 to 10. During this period, no principal payments are made, meaning the loan balance remains unchanged. After the interest-only period, the loan is typically converted to a traditional capital repayment mortgage, where both interest and principal are paid in regular instalments.
Before an interest-only mortgage is granted, lenders will need evidence that you are able to pay off the full amount at the end of the term, this is usually in the form of an investment, endowment policy, or ISA and is known as your “repayment vehicle”.
Pros of Interest-Only Mortgages.
- Lower Monthly Repayments – the biggest advantage of interest-only mortgages, helping to keep monthly costs lower, freeing up funds for other investment opportunities, financial goals or just to see you through a financial crisis.
- Flexibility – in times of irregular income, it grants you flexibility in managing your cash flow, allowing you the option to overpay if possible. The overpayments will only go toward the overall interest amount and not the loan amount.
- Investment Opportunities – the money you will save from only paying interest could go toward other investment opportunities, which could, in turn, earn you a higher return than it would by paying down your mortgage capital.
Cons of Interest-Only Mortgages.
- Increased Payments – you will pay more interest overall with interest-only mortgages because the amount you pay interest on doesn’t decrease during the loan term. Also, if property value declines, you could owe more than your home is worth, creating difficulties when you decide to sell or refinance.
- Balloon Payment – at the end of the interest-only period, borrowers are faced with a balloon payment, which is a lump sum that includes the remaining loan amount.
- Looking After Your Repayment Vehicle – ensuring it makes enough money to pay off your mortgage. Investments, pension funds, an inheritance, or a rise in house price are good examples of a repayment vehicle but evidence is needed to show it can produce enough money to cover the full cost of your mortgage.
- Lack of Equity Building – not paying off any capital toward your loan means your ownership stake in the property is reduced and you cannot build any equity in the property.
Alternatives to Interest-Only Mortgages in Times of Financial Crisis.
If the thought of an interest-only mortgage is a little overwhelming, there are still options for you that will help ease the monthly pressure-
- Consider remortgaging with a lower interest rate, especially if you are on an SVR (standard variable rate) mortgage or tracker mortgage. A 2 or 5-year fixed-rate deal could offer lower monthly payments.
- Extend your mortgage term by spreading what you owe over a longer period and reducing your mortgage payments each month.
- Switch to a cheaper mortgage insurance provider. It’s common for lenders to be tied to one provider of mortgage, building, and contents insurance so it could pay to look around at cheaper deals yourself.
- Consider an offset mortgage that is linked to a savings account and uses its balance to cut the interest charged against your mortgage.
- Improve your LTV (loan-to-value ratio) to gain access to better deals when remortgaging. Your LTV tells you what percentage of your home’s value is borrowed, for example, if you buy a £100,000 house and you pay a £20,000 deposit, your LTV is 80% because you have already paid 20%. The higher your LTV the greater risk you pose to lenders so working on lowering this figure could mean you get access to better deals and lower mortgage payments in the future.
- Work to improve your credit score to prove to lenders you are reliable and possibly get access to better mortgage deals.
Things to Consider Before Opting for an Interest-Only Mortgage.
Understanding your financial stability before entering an interest-only mortgage is vital. It’s easy to be lured into a false sense of security with reduced monthly payments but once your term is over, you will be hit with vastly increased payments to pay off the loan. It’s also advisable to ensure you have a stable repayment plan in place once the interest-only term ends. Ensure you understand the risks involved and give your lender evidence of your plans to repay. Once you have your interest-only mortgage in place it is also crucial that make your monthly payments on time and in full. Late payments could lead to penalty charges, getting defaulted or a CCJ, and possibly even losing your home. Setting up a direct debit is a good way to ensure you never miss a payment.
The Importance of Reliable Advice from a Reputable Mortgage Advisor.
As with every form of borrowing money, interest-only mortgages are a risk, however, they may just be the solution you need right now to ensure you can manage through this time of financial uncertainty. If you are thinking about getting this type of mortgage, it’s highly advisable to use a reputable mortgage broker, who can offer the help and advice you need for your specific circumstances.
TaylorMade is Manchester’s leading mortgage advisor, with experience in an array of mortgages, we work with you to ensure you can live comfortably within your means.
If you would like to speak to a helpful and friendly mortgage advisor at TaylorMade, get in touch today. We are a mortgage broker equipped with knowledge and experience and we’re waiting to help you.
Source: Mortgage Strategy
