What is an interest-only mortgage?
As it says on the tin, an interest-only mortgage means you only pay the interest on your loan back to the bank or building society during the term of the loan, and not the capital. This has to be repaid at the end of the term, in one go.
Ideally you should use an investment vehicle such as an endowment, pension or ISA to build up the funds to repay the capital. At the end of the agreed mortgage term, this ‘should’ have performed well enough for you to clear the debt. But – as we have seen with under-performing endowments – there are no guarantees.
Many interest-only borrowers, however – in fact 77%, according to the latest figures from regulator, the Financial Services Authority (FSA) – have no reported investment vehicle in place at all.
The short-term benefit of this mortgage option is that the monthly payments are lower. For example, a £250,000 repayment mortgage (where you pay back capital and interest throughout the term of the loan) with an interest rate of 4% would cost £1,320 a month, opposed to just £833 on an interest-only deal.
But of course, at the end of the agreed mortgage term, the property would not belong to you until the capital debt was cleared.
Why the focus on interest-only?
Royal Bank of Scotland and sister bank, NatWest, are the latest lenders to announce they will abolish residential interest-only mortgage deals for new customers, from December 3. The move follows the lenders’ decision to clamp down on criteria attached to the deals earlier in the year.
According to Moray McDonald, head of home lending at RBS/ NatWest, only 4% of customers apply for the deals. He said: “As a fast-growing UK mortgage lender we want to focus on the products most of our customers are asking for.”
The Coventry Building Society also announced it has shut its door on interest-only mortgages for new customers – again with effect from December 3. Sales and marketing director, Colin Franklin, says interest-only mortgages have declined to less than 2% of the building society’s residential mortgage applications, so, again, the deals are no longer worth investing in.
RBS, NatWest and the Coventry follow in the footsteps of the Co-operative Bank and the Britannia and Nationwide building societies, which also pulled the plug on interest-only deals earlier in the year.
What happens if I already have an interest-only mortgage with one of these lenders?
If you are already on an interest-only deal with one of these lenders, you won’t be immediately affected by the changes. The terms and conditions of your existing contract can’t be changed.
However, when it comes to the end of your current mortgage deal you will not be able to switch to another product on an interest-only basis and you could be forced onto the lender’s standard variable rate (SVR) which can prove a lot more expensive.
The Coventry, for example, has an SVR of 4.74% which compares with 2.59% for the cheapest mortgage on its shelves – a two-year fix at a 65% loan to value ratio.
On the flipside, though, this shows that, while switching to a repayment mortgage is more expensive, the rates you’ll have access to are likely to be cheaper. So in some cases, the move might not make too much difference to your monthly outgoings.
As ever, do your sums and if you need some help, contact our independent mortgage partner, London & Country on 0844 209 8725. There is no charge for the service they offer.
Can I borrow more?
If you want to increase your borrowing even without remortgaging, you will not be able to do so on an interest-only basis. You will have to switch to a repayment mortgage.
What about if I want to move house?
You should be able to port your interest-only mortgage to a new home providing you can demonstrate that you can afford the deal and the new property provides adequate security for the loan.
Can I still get an interest-only deal from another lender?
It’s still theoretically possible to still get an interest-only deal but criteria are becoming so strict that it might not work in practice.
For example, alongside RBS and NatWest, a spate of other lenders clamped down on interest-only criteria earlier this year. The Woolwich (the mortgage lending arm of Barclays), for example, changed its rules to state that any repayment vehicle operating alongside an interest-only loan must have been in place for at least 12 months before application.
And Lloyds Banking Group (which incorporates Halifax, Lloyds TSB, Cheltenham & Gloucester and Scottish Widows) said it would no longer consider certain cash savings plans, such as ISAs, as an acceptable means of repaying the capital. Of the ones it would accept, it would not factor in any growth in its lending calculations.
Some lenders such as Leeds Building Society and Santander also pegged down the maximum loan to value attached to interest-only loans in both of these cases to 50%.
Most lenders have now outlawed the potential proceeds of a property sale as a projected means of repaying the capital.
So will interest-only deals become a thing of the past?
It’s unlikely the latest cull will mean the end of interest-only deals as the FSA’s recently-published Mortgage Market Review (MMR) states there is still a place for the deals, so long as lenders ensure borrowers have an adequately-robust repayment plan in place.
But choice is waning fast. Our figures at MoneySupermarket found there are currently only 211 interest-only deals available from 27 lenders, while this time last year there was 485 again from 42 lenders.
It’s still business as usual, however, for interest-only mortgages on buy-to-let homes as these deals are not classed as ‘residential’.
Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct