An interest-only mortgage can be an attractive option for homeowners looking to reduce financial pressure felt under the weight of the current mortgage landscape. If you are looking for information on how interest-only mortgages work and why it could be beneficial to you, we’ve compiled a list of some of the key questions to be aware of.
As the name suggests, an interest-only mortgage is a type of mortgage whereby your monthly payments are paying off the interest on the total amount you have borrowed. The remaining loan amount will however need to be paid once the original mortgage term has ended. A standard repayment mortgage, on the other hand, requires a monthly payment that covers the interest and a portion of the loan amount, therefore this repays the whole mortgage over time.
This depends entirely on your individual circumstances, but it can be a good option for those who have a savings plan in place to eventually cover the actual mortgage amount. It can also be a good choice for those who might be anticipating a struggle with repayments in light of the recent interest rate increases. There are some caveats to be aware of; the lender will need to see some proof that you will be able to pay back the loan amount after the term ends. This is called a repayment vehicle, and could be something like the sale of a property or the lump sum cash element of a pension, or a savings plan such as an ISA.
Alternatively, you could remortgage your home at the end of the term and use that money to pay off the debt, but this will depend on many factors including your age and affordability of the new payments.
Anyone can apply for an interest-only mortgage but they can be tougher to secure than a standard repayment mortgage due to the fact that the lender will need to see evidence of your ability to eventually repay the full loan amount.
The main negative of an interest-only mortgage is that you are not reducing the overall debt amount each month, which means that you will still owe the original amount borrowed. There is also the issue of your repayment vehicle; you will need to ensure this remains in place, and things like investments and inheritance amounts can be unpredictable, thereby potentially leaving you with less than you anticipated when the time comes to pay off the remaining loan amount.
Regardless of the potential downsides, interest-only mortgages remain a popular choice for many homeowners, with 702,000 full interest-only and 222,000 partial interest-only mortgages in place at the end of 2022. Although these numbers are down versus 2021, they might increase due to the current mortgage landscape being so unpredictable. One of the reasons why they are popular is their flexibility, with homeowners able to make lower payments to start with and then higher payments when they come into more money towards the end of their term.
There are mortgages designed for retirement whereby the loan is repaid when the last survivor or when the last person leaves the property. These are called Retirement Interest Only Mortgages (RIOs), and Interest Only Lifetime Mortgages. The difference with the above is that if you stop paying the monthly interest with a RIO, your home can be repossessed, however with an Interest Only Lifetime Mortgage, you cannot be repossessed when taking out a plan that is covered by the Equity Release Council. Advice should be taken from a specialist regarding these plans from an Equity Release Council adviser such as Bower Home FInance.