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Interest-only Mortgage Advice
If you’re looking for an interest-only mortgage, then it’s likely that you will be facing an uphill struggle to find enough insights on lenders and products to make a truly informed decision. Due to caution on the part of lenders, information in the public realm is quite limited, as are the options for services. The majority of lenders offering interest-only mortgages only work through trusted intermediaries such as specialist mortgage brokers, without advertising their deals, and so anyone trying to search online will not be able to see what the most favourable options are nor where to find them.
An interest-only mortgage, when managed effectively, can be an excellent way to keep your monthly payments down while storing up an investment for your future. Our team at The Mortgage Centres includes specialists ready to help you with decades of experience in interest-only mortgages and an in-depth understanding of the UK mortgage market.Read More
Our close working relationships with a broad spectrum of lenders – from those on the high street to niche-market specialist companies – mean we understand exactly their approach to mortgage applications and their processes for assessing whether they will be willing to lend. It also often means we are able to access better rates for an interest-only mortgage than if you had approached them directly yourself, saving you potentially thousands of pounds in the future.
This section will outline more details regarding interest-only mortgages and some of the things you will have to watch out for. If you have any questions about how any aspect could relate to your individual case, please get in contact with our team. We’ll be happy to discuss the benefits of an interest-only mortgage and help identify exactly the right lender and deal to suit your aims and needs.
Interest Only Mortgage Information
What is an Interest-Only Mortgage?
An interest-only mortgage differs from a repayment mortgage in a very significant way. With a repayment mortgage, your monthly instalments go towards paying down the mortgage amount as well as covering the interest, and slowly both decrease over the planned period of time until the loan is repaid. This is sometimes referred to as a ‘capital and interest’ mortgage, to differentiate it from an ‘interest-only’ mortgage. With interest-only, your repayments each month only cover the interest charged on the whole loan amount, so the loan itself does not reduce.
The main advantage of interest-only mortgage is that the monthly payments are usually significantly less than those for a conventional repayment mortgage. However, with none of the loan being paid off, you will need to pay money on top of this into another fund so that you will be able to do so when your mortgage comes to term, if not before.
This kind of plan is often referred to as a ‘repayment vehicle’, and can take the form of an endowment policy, pension, ISA or another account or fund that accrues interest. In some cases, the mortgage is paid off by the sale of the home itself, which you could anticipated to have gained value over the course of the mortgage.
Lenders offering interest-only mortgages each have their own criteria for what they are willing to accept as repayment vehicles, and may reject those that they think will not give the borrower enough return on their deposits to offer enough security on the full home loan, one example being cash in a standard savings account. You should always check your plans with an experienced mortgage adviser, if not your lender.
Differences between Interest-Only and Repayment mortgages
As mentioned, the significant difference between interest-only and ‘capital and interest’ mortgages are that, as the name implies, you pay only the interest on the mortgage for the duration of the loan, and none of the mortgage capital. This will result in significantly lower monthly payments to the lender, but because the loan amount itself is not decreasing it means that you will be charged more interest over the loan period than if you had been paying off the mortgage incrementally.
It’s best to show how interest-only and repayment mortgages might compare with some examples. At any point in time, there will be a huge variety of mortgage products and rates available, but for the sake of simplicity, we will look at scenarios with representative interest rates of 3%, 4% and 5%. We’ll base our examples on a purchase price of £232,000, with the buyers putting down a 25% deposit and obtaining a mortgage of £174,000 over a term of 25 years.
Please note: this illustration should not be considered as mortgage advice. Actual figures in your case may differ according to several influencing factors. Always talk to a specialist mortgage adviser to get an accurate comparison.
|Interest Rate||Interest-Only Mortgage||Repayment Mortgage|
|3%||Monthly payments: £435
Total amount repayable over the term: £304,500
(comprising: the £174,000 borrowed, to be repaid at the end of the term, plus total interest of £130,500, paid in equal monthly payments over 25 years).
|Monthly payments: £825
Total amount repayable over the term: £247,538
(comprising: the £174,000 borrowed, repaid in the monthly payments over 25 years, plus total interest of £73,538 also paid as part of the monthly payments).
|4%||Monthly payments: £580
Total amount repayable over the term: £348,000
(comprising: the £174,000 borrowed, to be repaid at the end of the term, plus total interest of £174,000, paid in equal monthly payments over 25 years).
|Monthly payments: £918
Total amount repayable over the term: £275,531
(comprising: the £174,000 borrowed, repaid in monthly payments over 25 years, plus total interest of £101,531 also paid as part of the monthly payments).
|5%||Monthly payments: £725
Total amount repayable over the term: £391,500
(comprising: the £174,000 borrowed, to be repaid at the end of the term, plus total interest of £217,500, paid in equal monthly payments over 25 years).
|Monthly payments: £1,017
Total amount repayable over the term: £305,156
(comprising: the £174,000 borrowed, repaid in monthly payments over 25 years, plus total interest of £131,156 also paid as part of the monthly payments).
It’s important to note these calculations have very much simplified the process, and do not account for interest rate fluctuations, home insurance, redundancy insurance nor payments to (and interest from) a repayment vehicle.
What is a part-and-part mortgage?
A ‘part-and-part’ mortgage is a way of combining the two methods of payment, such that you pay towards a portion of the loan amount on top of interest payments, and arrange a payment vehicle to pay into to cover the balance of the mortgage when it reaches the end of term.
For example, if you take out a mortgage of £160,000 you could have a repayment vehicle covering £100,000, which would be on an interest-only basis, and the balance of £60,000 would be paid off as per a repayment mortgage as part of the monthly payments.
The lender would calculate monthly payments to include a sum to steadily repay the £60,000 portion of the mortgage labelled for repayment over the term of the arrangement as well as covering the interest accruing on the remaining mortgage balance. At the end of the mortgage period, the loan amount will have reduced from £160,000 to £100,000 and you would pay off this balance using the repayment vehicle.
This provides a convenient compromise between a solely interest-only mortgage or entirely repayment home loan. Your monthly payments will be less than for the equivalent standard repayment plan, you will need less in your repayment vehicle and because the loan amount reduces during the term of the loan, you will pay less interest than on a fully interest-only arrangement.
Who might be suited to an Interest-Only mortgage?
An interest-only mortgage might not be right for everyone. It can require some careful management and planning, and some lenders do not offer interest-only mortgages at all. However, this kind of mortgage can offer some advantages and benefits to those whose personal circumstances and individual borrowing needs fit with an interest-only scenario, and we have seen all types of borrowers, from first-time buyers to Buy-to-Let investors and established home movers make good use of this model.
In particular, in London and areas of the South East where property prices are high, an interest-only mortgage can be seen as a convenient way to get on the housing ladder. The monthly payments will be cheaper than renting a property, while you will still own your own home (even if not paying off the mortgage capital) which you will be likely to sell at a profit at the end of the mortgage term.
Buy-to-Let investors often use interest-only mortgages as a way of keeping their monthly costs low while accruing value in the property, again anticipating that house prices will rise over the years. This will maximise their monthly income while also giving them the option to make lump-sum part payments from time to time to reduce their overall commitment and interest costs.
Interest-only mortgages can also present the same attractive low monthly commitments to people whose income may fluctuate, such as contractors, freelancers and the self-employed, while, again, also allowing them to pay off chunks of the mortgage when they are able to do so and decrease the overall mortgage amount.
Interest Only Mortgage Lenders
There are far fewer lenders willing to consider interest-only mortgages than there once were. For a long time, interest-only was a popular option as the high interest rates on savings and endowments in the late ‘90s and into the first decade of the 2000s meant borrowers could keep their monthly payments low and rely upon their endowment plan growth as an effective method to pay off the whole mortgage amount at end of term.
However, when interest rates nosedived in the wake of the financial crisis of 2008-9, many borrowers found their endowments were not delivering the return they had expected. Many homeowners were left in serious financial trouble when their policies were unable to meet the sum still outstanding on their mortgages. This led inevitably to a decline in the popularity of interest-only mortgages, with borrowers preferring the safety of a standard fixed-rate or tracker mortgage.
With the decline in demand, and the increased risks posed by an interest-only plan, the majority of lenders decided to withdraw interest-free mortgage products from their portfolios or restrict their access to only those meeting the most stringent criteria.
Currently, you can still get interest-only mortgages from some of the specialist, niche-market lenders in the industry, but they will look at the arrangements very carefully and apply strict criteria for borrowers to meet. At a minimum, you will need to show you have made adequate arrangements for a repayment vehicle to cover the full amount of the mortgage (or part that you are leaving as interest-only) and supply a reasonable level of deposit – typically 25%. Individual lenders may have further criteria according to their own policies on interest-only arrangements.
You will not find these specialist lenders on the high street or advertising online, as they invariably work through trusted third parties, like established mortgage brokers, to ensure that someone has conducted a vetting process to ensure potential clients will be suitable for their business and likewise that their products will be the right deals for borrowers. To find out more about your interest-only options with specialist lenders, please talk to one of our expert team.
Overall, we have access to over 12,000 products through 90+ lenders, and know there will be a match for your needs out there. Get in touch with our team to arrange a free, no-obligation initial consultation and get clarity on which mortgage options will work for you.
Interest-Only Mortgage FAQs
- Can I sell my mortgaged property to repay the interest-only mortgage?
- What happens at the end of the term of the mortgage on an Interest-Only mortgage?
- Do I need to have a repayment vehicle in place to have an interest-only mortgage?
- Can all mortgages be placed into interest-only?
- Can I change from interest-only to a repayment mortgage later on?
If you are already in an interest-only mortgage agreement, then it’s likely that the lender would have ensured you are accruing sufficient funds in an endowment policy or an ISA to pay off the mortgage when it reaches the end of term. However, in some cases the repayment strategy would have been the sale of the property, and if it has increased in value over the period of the mortgage them you will be able to sell it to pay off the loan, and possibly use the profit as a down payment on your next property, or to buy a lower-value property outright.
If you are looking to take out a new interest-only mortgage, then you will face more resistance, as most lenders will not now accept the sale of the property as a valid repayment plan. You will likely be required to show you have an alternative payment plan in place to meet the full mortgage amount, although some lenders might consider it if the loan-to-value ratio is quite low and other aspects of your situation meet their criteria.
Over the course of the mortgage period, you will have been paying off solely the interest on the full mortgage amount each month, so the actual mortgage sum will have remained the same, unless you have also made any capital contributions to reduce it. This sum will need to be paid off in full when the mortgage reaches the end of term, usually from the monies accrued in an endowment policy, ISA, pension, or another investment plan that would have been set up for this express purpose, usually known as a ‘repayment vehicle’. If you find that your repayment vehicle has not returned sufficient funds to cover the full amount of the mortgage, then you may have to sell the property to meet that debt, unless you find another source of finance.
The short answer is yes, you do. Lenders who currently offer interest-only mortgages are obliged by regulations to ensure that borrowers can both afford the monthly payments and have arranged a repayment vehicle that will sufficiently cover the whole balance due at the end of the mortgage period. You will need to provide verification that you have done so to the lender when you apply for the mortgage and it’s likely that the lender will make checks on the status of your repayment vehicle during the time you are paying off the interest, to make sure that it is on track and their loan is secure.
If you are already in an existing interest-only agreement, then it may be that you did not need to provide this verification, as the rules were less stringent in the past. It’s worth checking to make sure that your repayment plan is on track, and if there are any concerns over its ability to cover the mortgage sum you should contact your lender to discuss your options.
It’s not common, but there are a handful of lenders who will accept a borrower switching their mortgage from a repayment plan to interest-only. A lot will depend on your individual circumstances, the loan-to-value ratio and the equity already in the property, and you will certainly need to show that you have an effective repayment vehicle in place to cover the remaining amount due on the mortgage on an interest-only basis. You will need to discuss the exact situation with an experienced mortgage adviser to get an accurate assessment of your options.
This is actually quite possible, and most lenders will permit borrowers to switch their interest-only mortgage to a repayment plan during the mortgage term. You may be able to do this by remortgaging with your existing lender, or by looking for a deal from an alternative lender, if the terms of your existing mortgage allow. You may also want to consider switching to a ‘part-and-part’ mortgage whereby a portion of the mortgage amount remains interest-only while the remainder is paid off on a repayment basis.
Changing your mortgage in this way is useful for people who can see that their repayment vehicle will not deliver the return over time that they expected in order to cover the mortgage amount at the end of term. It’s worth monitoring your fund’s performance regularly to make sure that the finances around your home are on track.
A broker with experience in handling these kinds of issues in the past will be able to comprehensively guide you through all the steps you need to take, and will have the insight to ensure you come away with the most favourable deal possible.