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What is an interest only mortgage?

An interest only mortgage is where you (the borrower) is only obligated to pay off the interest on your mortgage each month. Quite often repayments on the capital are optional, but the whole capital debt is normally only repayable at the end of the pre-agreed term.

There are various types of interest only mortgages available:

  • Later life over 55: Equity release
  • Retirement interest only mortgages
  • Interest only buy-to-lets

 

How does an interest only mortgage work?

A debt consolidation mortgage allows you to move all of your existing unsecured borrowings into one loan – your mortgage. Therefore, you only need to make a single monthly payment, rather than separate payments to different lenders with different terms and interest rates. 

To consider you for this type of mortgage, a lender will take a look at:

  • How much your property is worth
  • Your credit report
  • What debts you have
  • How much of your home you own outright
  • How much you want to borrow compared to your income

Some lenders will ask you to sign an undertaking, drafted by a solicitor, before they will agree to your mortgage terms. By signing this, you commit to repay your debts in full, but this may not be required depending on your income.

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How does an interest only mortgage work?

An interest only mortgage involves you borrowing money for a property, but you will only repay the interest each month. You don’t repay any of the capital owed until the end of the term. Interest only mortgages can be appealing, as it initially appears as though your monthly payments will be lower than that of a standard mortgage, and they can seem more affordable.

This isn’t necessarily the case, however, as you aren’t paying back any of the capital that you are actually borrowing, and you will be required to pay the total capital at the end of the term. This would have to be via a pre-approved repayment vehicle in place at the start of the mortgage; lenders will not use any speculative repayment vehicles that are not already in place at the start of the mortgage.

Types of repayment vehicle

– Current savings or investments

– Other properties, such as a buy-to-let or a holiday home

– Pension funds

– Sale of the mortgaged property (providing there is enough equity to downsize)

– Other assets

With any of the above repayment vehicles, the amount would need to be equal to or more than the proposed amount of mortgage borrowing at the outset.

What’s the difference between repayment and interest only mortgage?

With a repayment mortgage, you will make one payment a month to your lender. Part of this pays off your actual loan, whilst the rest covers the interest accumulated, so your payments for this will be higher than that of an interest only mortgage. As we’ve already covered, interest only mortgages only require that you repay the interest each month, so your monthly payments will be lower.

However, this does mean that you will have to make arrangements to pay back the capital in full at the end of the term. You may come across the term “repayment vehicle” which refers to using another investment or asset with enough value to cover the loan. The lender you go with will ask for proof that you have a legitimate repayment vehicle in place at the start of the mortgage.

Lenders may also have a minimum income requirement. Some will require that you earn as much as £100,000 per annum, whereas others won’t have a minimum income requirement. That’s why it’s so important that you get the right guidance from a specialist advisers.

Advantages of an interest only mortgage

Lower monthly payments

As you are only required to pay back the interest, your monthly payments will be far lower than those associated with a repayment mortgage. However, whilst this is an affordable option in the short term, you will still have to pay back the full capital amount once the term ends.

More control

With an interest only mortgage, you have more control over how you repay the capital on the mortgage once the term is up. You may decide to use the money saved on monthly repayments to make home improvements – and therefore potentially increase the value – and to set some aside in an investment or savings account to repay at the end of the term.

Profit potential

As long as you invest in a strong and reliable repayment vehicle, the amount may even give you additional money to use after your capital repayment has been covered. This could be used to cover additional home improvements, or could increase your mortgage payments – which means you pay off the capital and gain more equity faster.

Disadvantages of an interest only mortgage

Additional interest

Although you will pay less on a monthly basis, you could actually end up paying more interest in the long run. This is because you are charged interest on the full sum that has been borrowed for the term’s duration.

You will have to repay

After the interest only term ends, the remaining capital sum must be repaid. Although you will benefit from smaller monthly payments in the beginning, you will need to have a solid plan in place for repaying the capital, or you risk losing the property.

How to find the right deal for you

Getting any kind of mortgage can be stressful enough. Working with a specialist mortgage broker can help you get access to unique deals, as well as expert advice.

Interest only mortgage FAQs

What are the deposit requirements for an interest only mortgage?

The exact deposit requirements for an interest only mortgage will vary depending on the lender, your circumstances and the type of repayment vehicle being used, but it can be more challenging to secure an interest only mortgage. There are fewer lenders offering this type of agreement, and those that are may have put more stringent criteria in place for approval, such as a higher deposit.

Many lenders will require a 25% deposit, with a maximum loan to value (LTV) of 75%. Others may consider an 80% LTV, and some may stretch to 85%.

If you are using the sale of the mortgaged property as a repayment vehicle, typically lenders will require a larger equity in the property at the outset, or even cap the LTV at 50%.

What if I can’t afford to pay off my interest only mortgage at the end of the term?

If at any time you are worried that you won’t be able to pay off the capital amount at the end of your mortgage term, you should take action as soon as possible to avoid the risk of losing your home. Even if you are years away from the term ending, here are some of the options available to you:

  • Downsizing
  • Asking your lender for an extension
  • Selling another property in your portfolio
  • Using savings, investments or a pension
  • Remortgaging
  • Equity release
  • Switching to a repayment mortgage

What is an interest only mortgage payment holiday?

A payment holiday on any mortgage, including an interest only mortgage, is where you agree with the lender to temporarily stop or reduce your monthly payments. Once this holiday ends, you will have to start paying again. Usually the payments will increase to make up for the missed months and the additional interest owed. This service isn’t offered by all lenders.

Can I refinance an interest only mortgage?

Yes, refinancing is possible on an interest only mortgage if you meet the lender’s affordability and eligibility criteria. You could also remortgage to another interest only plan or even look at changing to a repayment mortgage.

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