An interest-only mortgage is a type of mortgage where your monthly repayments only repay the interest on your loan, not the loan itself.
This means that the loan itself isn’t repaid over time but will still need to be repaid in full at the end of the mortgage term or sooner.
What is an interest-only mortgage and how does it work?
If you take out an interest-only mortgage, you’ll still be charged monthly payments by your lender. This payment will be smaller than the monthly cost of an equivalent repayment mortgage.
However, these payments won’t reduce the size of the loan – they’ll just cover the interest on the loan each month, so the loan sum won’t grow any bigger but will remain the same.
So, for example, if you borrow £100,000 on a 20-year interest-only mortgage, at the end of that 20 years you’ll still owe £100,000.
When your interest-only mortgage term comes to an end, you will need to repay the loan somehow – either by selling the property, using savings, or taking out another mortgage (remortgaging).
What happens at the end of an interest-only mortgage term?
When the term of your interest only mortgage comes to an end, you will face a bill for the full amount of the original loan.
You will therefore need to have a plan in place for how you will repay this.
How can I repay my interest only mortgage?
There are several ways you might repay an interest-only mortgage:
Remortgage
You can repay an interest-only mortgage simply by taking out another mortgage (which could be repayment or another interest-only one).
However, you’ll need to make sure you still meet a lender’s criteria – you’ll be older by this time, and your circumstances may have changed.
Sell the property
You can of course sell a property to repay an interest-only mortgage.
This is more common among those who buy to let. If you are lucky, the property price will cover the whole loan amount with some left over – but if you are unlucky and run into negative equity, you would have to cover the shortfall.
Use savings & investments
If you have accumulated enough money in the form of other investments, you could use these to pay off your interest-only mortgage.
This was the principle behind the ‘endowment mortgage’, but these products became obsolete when many homeowners found that their investments could not generate enough returns to repay their mortgage loan.
What if I can’t repay my interest-only mortgage?
If you can’t repay your interest-only mortgage by other means, the property that you’ve bought with it will have to be sold.
If the sale of the property is not enough to cover the loan (i.e. it is in negative equity) then your other assets may be at risk.
Interest-only mortgages – the pros and cons
Here are the advantages and disadvantages of an interest only mortgage.
Benefits of interest-only
The main benefit of an interest-only mortgage is that your monthly payments will be cheaper.
This means that you could potentially borrow more with some mortgage lenders.
If you are buying your own home, an interest-only mortgage may help you to afford a more costly property than you otherwise could – provided you have a repayment strategy in place for the end of the mortgage term whether that be from investments, a pension payout or selling the property.
If you are purchasing a Buy to Let property, an interest only mortgage can be more convenient, as it keeps your overheads lower, and when the term expires you can just sell the property to repay the loan.
Downsides of interest-only
The biggest drawback of an interest only mortgage is that you don’t pay off the loan as you go.
This means you must find another way to do this – you can’t just forget about it!
Another downside of interest-only is that the total amount you repay over time will be greater.
Finally, it is harder to find interest-only mortgage deals, and even more so as a First Time Buyer who tend to have smaller deposits.
You are likely to need a much bigger deposit and a higher income – which may well cancel out any advantage that comes from cheaper repayments.
Who gets an interest only mortgage – and should I?
The most popular use of the interest-only mortgage is for property investors looking to purchase Buy to Lets although there are occasions when those looking to purchase their residential home may be better suited to an Interest Only mortgage. Your mortgage adviser will be able to go through your individual needs and circumstances and make an appropriate recommendation.
If you would like to discuss your mortgage arrangements with one of our experienced advisers, please contact us here or alternatively call us on 01702 746811 for a no obligation chat.
Your home may be repossessed if you do not keep up repayments on your mortgage.