We explain how interest-only mortgages work, and look at the options for those worried about paying off the amount borrowed at the end of the term.
What is an interest-only mortgage?
With an interest-only mortgage, you pay off the interest on a loan, but not the capital.
This means that the monthly repayments are generally a lot lower than those on repayment mortgages. But the amount owed does not go down over the years as it does with a repayment deal.
As a result, at the end of the mortgage term, you need to find a way to pay back what you owe in one lump sum.
Most people use an investment vehicle such as an endowment or ISA to build up the funds to do this.
The aim is for this investment vehicle to perform well enough to cover – or even exceed – the original amount borrowed.
However, there are no guarantees and while some borrowers manage to build up sufficient savings, many others find it difficult to invest enough to pay off the capital.
How many people have interest-only mortgages?
At the beginning of 2018, the FCA released figures showing there were 1.67 million part- and full interest-only mortgages outstanding in the UK.
As its figures also showed around 85,000 of those deals were due to mature in 2018, the current total is likely to be around 1.6 million.
Interest-only mortgages were very popular in the years leading up to the credit crunch, which took hold in 2008.
Since then, many lenders have stopped offering them, while those still in the interest-only market have tightened up their lending terms.
Which lenders still offer interest-only deals?
Interest-only mortgages are still available for residential properties.
Lenders still offering deals of this kind include Halifax, Skipton Building Society and Leeds Building Society.
However, to qualify you are likely to need to have a very high income and a deposit of at least 25% of the property’s value.
Most lenders also now require you to have an approved repayment vehicle in place to pay off the capital at the end of the term.
Are interest-only deals on the way out?
Interest-only deals continue to be a valid option for homeowners and buyers who pay regularly into an approved repayment plan.
They also remain a popular option for buy-to-let landlords, many of whom pay their mortgages on an interest-only basis.
In recent years, lenders have also started offering more part-and-part mortgages, which are part interest-only, and part repayment.
The advantage of these part-and-part mortgages is that they allow you to keep monthly payments down.
However, lenders will still require evidence of a repayment vehicle for the interest-only portion of your mortgage.
Say you want to borrow £75,000 to buy a house worth £100,000.
You may be offered a part-and-part mortgage with which you can borrow up to 50% of the property value on an interest-only basis.
In this case, your payments to the lender would therefore be interest-only on £50,000 and repayment on the remaining £25,000.
My lender has stopped offering interest-only mortgages. What does this mean for me?
The terms and conditions of your interest-only deal should not change just because your lender decides to stop offering interest-only loans.
However, you may be moved onto an uncompetitive standard variable rate (SVR) when your current deal matures, so it’s best to then switch to a better deal.
I will not have enough savings to pay off my interest-only mortgage. What are my options?
If you know your investments are unlikely to cover the capital repayment when your interest-only mortgage comes to an end, it’s best to start taking action now.
According to the FCA, the next two maturity “peaks” for interest-only mortgages are 2027-28 and 2032.
Many homeowners therefore have at least nine years to make a dent in their savings shortfalls by increasing their contributions and maximising their returns.
If this isn’t possible, there are four main options available:
- Take out a new interest-only deal
- Switch to a repayment mortgage
- Sell your home
- Consider equity release
1. Take out a new interest-only deal
You may find you are able to take out a new interest-only mortgage, but this will depend on your personal circumstances.
If, for example, you have a loan-to-value (LTV) percentage of less than 75%, you’re more likely be accepted for a new interest-only deal compared to someone who has an LTV higher than that.
If you’re now in your 70s, taking on a new mortgage may also be more challenging. If this is the case, it’s worth looking into specialist deals.
2. Switch to a repayment deal
If you are unable to pay back what you owe at the end of an interest-only deal, your lender may be prepared to extend the term of your mortgage and switch it to a repayment basis.
This is a good option if you can afford it. However, be aware that your monthly repayments will increase significantly, so check what they will be before agreeing to anything.
3. Sell your home
If you haven’t been able to invest enough, or your investments haven’t performed well enough to clear what you owe, you may find your only option is to sell your home.
Keep in mind though that if the value of your home has fallen since you took the mortgage out, you may not completely clear what you owe.
4. Take out an equity release plan
If you are at least 55 years old, an equity release scheme offers another way to pay off your debt without selling your home – as long as you own at least 45% of your home.
There are two main types of equity release products:
- Lifetime mortgage – a mortgage secured on your property on which you make repayments or let the interest roll up (where it’s added to the loan). This loan won’t need to be repaid until you pass away or move into long-term care, when your home will be sold
- Home reversion – the sale of your home, or part of it, to an equity release company. You can continue living in the property rent-free – you’ll just need to maintain and insure it. When you pass away or move into long-term care, the property is sold and the proceeds are shared between the company and your heirs accordingly
What is right for you will depend on your individual circumstances, such as how much you owe, how much your home is worth, and the terms of your repayment plan.
Interest-only mortgage action plan
Worried about paying off your interest-only mortgage? Taking these three steps is a good start…
- Check when your loan is due for repayment and how much you will owe when it does
- Check how your savings are doing
- If the total is lower than the amount you need to repay, consider increasing your contributions or switching to a new deal
Your mortgage is secured on your home, which you could lose if you do not keep up your repayments.