What is an interest-only mortgage and how does it work?
An interest-only mortgage is a type of mortgage that allows you to only pay the interest charges each month for the loan term. This means you don’t have to repay the amount you’ve borrowed until the end of the term. When taking out an interest-only mortgage, you will still make monthly payments to your lender, but the payments are usually a lot less than the monthly cost of a repayment mortgage.However, these payments will not reduce your loan size. Instead, these payments will pay off the interest as it builds, meaning that the sum of the loan does not continue to rise. For example, if you borrow £100,000 on a 20-year interest-only mortgage, at the end of the 20 years, you will still owe the full amount of £100,000, but you will have already paid any interest that would have built up otherwise.
Why choose an interest-only mortgage?
An interest-only mortgage may not be the right fit for everyone, but it may be an option for those of you who have a clear plan to save.When you come to the end of the term of the interest-only mortgage, you will then need to repay the remainder of the loan in some way e.g using savings, selling the property, or remortgaging.
Should I get an interest-only mortgage?
With Interest-only mortgages, there are stricter regulations upon lenders who offer them. Due to the nature of an interest-only mortgage, there are stricter regulations to avoid customers being landed with a large amount of debt that they can’t handle in the future.What are the benefits of an interest-only mortgage?
- Your monthly payments are much lower than that of a repayment mortgage, as you’re only paying the accrued interest amount of the loan - this means you could potentially borrow more providing you would be able to afford the final cost of the property.
- If you’re buying to let, an interest-only mortgage can often be more convenient as it keeps your overhead costs lower, and when the term comes to an end you can sell the property to help you repay the loan.
Drawbacks:
- The main drawback is that you do not pay off the total sum of the loan as time passes. This means you have to find an alternative way to do this and make sure that you stick to your plan.
- You will have to budget for paying a monthly or annual contribution to a savings plan or endowment policy so that you can accumulate the funds to pay off the mortgage on completion
- When choosing an interest-only mortgage, you are more likely to require a bigger deposit and a high-income amount. This can then negate any of the advantages that come from choosing this type of mortgage.
- There is a higher risk of negative equity than with a repayment mortgage. The mortgage balance remains the same over the term of the mortgage, meaning you’re more exposed to changes in house prices.
- If you get to the end of your mortgage and you have no means of paying off the loan, there is a risk your property will be repossessed.
