Interest-only mortgages can offer a more affordable way to get on to the housing ladder.
But is an interest-only deal right for you?
What is an interest-only mortgage?
With an interest-only mortgage, you only pay off the interest on your loan, not the capital.
At the end of the mortgage term, you therefore need to use savings, investments or other assets to pay off the capital.
In comparison, with a repayment mortgage, you pay off some of the capital alongside interest each month – ensuring that the full amount is repaid by the end of the term.
What sort of investments can be used to repay the capital?
Most people use an investment vehicle such as a tax-efficient ISA (cash or stocks and shares) to raise the funds required.
Whatever type of investment you choose, you must invest enough to show the lender you will be able to clear the original amount borrowed (minus the interest).
It is essential to review your investment plan regularly to make sure it is on track – and to take action if it is falling short of the mark.
How much do I need to invest alongside my mortgage?
The amount you need to invest depends on a number of factors including the size of your mortgage and the length of the deal.
You may have to increase your payments if your investments fail to perform.
What happens if I don’t have enough money to pay off the capital at the end of the mortgage term?
In an ideal world, your investment vehicle will perform well enough to clear the outstanding debt at the end of the term.
However, there are no guarantees.
If you invest too little, or your investments fail to perform well enough, you may have to sell your home to clear the capital debt.
And if the value of your home has fallen since you took the mortgage out, you could find that even selling up will not clear your debt.
What are the options if I am facing a shortfall?
There are a number of options open to you if you realise that your savings will not be sufficient to clear your mortgage debt.
- Switching to a repayment mortgage deal. This will help you to make big inroads into your debt, but will generally mean much bigger monthly payments.
- Making overpayments. Most lenders will let you overpay by up to 10% of the mortgage amount each year. Any sum you pay off will no longer be liable for interest, seeing more of your monthly repayments go towards the capital.
- Increasing your investments. Upping the amount you pay into your investment vehicle may allow you to make up the difference.
- Extending your mortgage term. A longer timeframe may allow you to build up your savings, or make switching to a repayment mortgage much more affordable.
- Using equity release. Older borrowers can use equity release mortgages to continue living in their homes while paying off the outstanding debt.
Which lenders offer interest-only deals?
Interest-only mortgages fell out of favour in the post-credit crunch era, when many lenders stopped offering them altogether.
Now, though, they are back.
NatWest, Barclays, Santander and Halifax, for example, all offer interest-only mortgages.
Some lenders, however, only offer “part” interest-only deals.
If you want to borrow 75% of a property’s value with Leeds Building Society, for example, the building society will lend you up to 50% on an interest-only deal and the other 25% on a repayment basis.
Mortgages of this kind are also known as “part and part”.
Can I move home with an interest-only mortgage?
You should be able to port your interest-only mortgage to a new home so long as you can demonstrate the new property provides adequate security for the loan.
However, if you want to increase the amount borrowed, you will have to show that you can invest enough to clear the capital or switch to a repayment mortgage.
Is an interest-only mortgage right for me?
Interest-only mortgages can be a good solution for people with variable incomes, such as self-employed workers, sales staff on commission and those who receive large irregular bonuses.
They also suit landlords who want to take an income from their property but will eventually sell it to clear the loan, and couples with a lower income due to one person taking a career break such as maternity leave.
Whatever your reason for taking one, you will need a plan for paying off the capital.
And even if this is to sell up or downsize, there must be enough equity in the property to enable you to do so.