Last updated: 23/07/2020 | Estimated Reading Time: 4 minutes
Mortgages can be complicated, and with the range of options out there it can be difficult to know which mortgage is right for you. Interest-only mortgages offer low monthly repayments making them seem attractive, but they are high-risk and less readily available than standard repayment mortgages. This guide will run you through the basics of interest-only mortgages, the advantages and disadvantages, and whether interest-only is the best mortgage deal for you.
In This Guide:
- What is an interest-only mortgage?
- Is an interest-only mortgage right for you?
- Repaying your interest-only mortgage
What is an interest-only mortgage?
An interest-only mortgage allows you to pay off just the interest on your borrowing each month, without paying the capital. This means you won’t pay off the loan and will still have to pay the full amount back at the end of the mortgage term in one lump sum.
Your monthly payments will be lower, which may make an interest-free mortgage seem attractive if you’re looking for a cheap mortgage. However, you are likely to pay more over time! We take a look at the advantages and disadvantages:
- Your monthly payments remain lower throughout your mortgage term.
- The money you save can be used to invest in your home and build its value.
- You have some flexibility with repayments as your plan may allow overpayments when you have more money available.
- Interest-only mortgages are usually riskier than other types of mortgage.
- Lenders rarely offer interest-only plans.
- Your debt is not reduced by your monthly payments, so you are likely to pay more overall.
- You will need to save to repay the amount you borrowed alongside paying the monthly interest on your mortgage.
Is an interest-only mortgage right for you?
Interest-only mortgages require savings or investments and are usually only suitable for those with lots of equity and a long-term repayment plan.
Interest-only mortgages are available for both residential, and buy-to-let mortgages, but are more common for buy-to-let properties. If you are a landlord seeking a mortgage for a buy-to-let property, interest-only mortgages are standard as your rental income can be set aside to help your repayment plan.
Interest-only mortgages on residential properties are typically only available to individuals with high-net-worth. The monthly repayments may be cheaper, but you are likely to end up paying more over time. This means you may not be getting access to the best mortgage deals with an interest-only mortgage.
Repaying your interest-only mortgage
Your lender will want to know from the start how you plan to repay the lump sum you borrowed at the end of your mortgage term. Different lenders will have different criteria for what is an acceptable repayment vehicle, and it’s a good idea to speak to a mortgage advisor to work out your repayment plan.
Your lender will likely ask for proof that your repayment plan remains on track throughout the mortgage term. They may want to discuss other arrangements if it looks like you won’t be able to repay what you owe.
It’s important to remain on top of your mortgage repayments. If you are concerned about repaying your mortgage there are a number of ways to ensure you are able to repay capital at the end of your mortgage term:
- Switching to a repayment mortgage will mean your monthly payment increases but it can help you ensure your mortgage is paid in full at the end of its term. Lengthening the term of your mortgage can minimise your monthly payments.
- Your lender may allow you to make overpayments to help you start reducing your debt. This could be particularly helpful if you have an irregular income.
- Paying into an investment plan which is then used to pay off the capital at the end of your mortgage can help ensure you save whilst repaying the monthly interest. A financial adviser will be able to suggest a suitable plan.
- You may want to think about re-mortgaging your home for a better rate. This could allow you to switch to a repayment mortgage over a longer term to make your monthly payments more affordable.
If you are concerned about repaying your interest-only mortgage, make sure to seek financial advice as soon as possible.