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Last updated: 23/07/2020 | Estimated Reading Time: 4 minutes

Understanding interest only mortgages

Interest only mortgages can seem enticing due to the lower monthly payments that they require you to make. This can seem like a good offer to many people because it means that the amount they pay back each month is hugely smaller than it would be on a standard mortgage. However a lot of people do not quite understand exactly what an interest only mortgage is.

This guide will explain everything that you need to know about interest only mortgages. We will talk you through the positives and negatives of this type of mortgage and how they compare to full repayment mortgages. It will also explain who is eligible to take out an interest only mortgage and what type of requirements a lender is likely to ask you to meet before you can be put onto an interest only mortgage.

In This Guide:

What are interest only mortgages?

Interest only mortgages are different to full repayment mortgages due to the fact that you are not required to make monthly payments towards paying off your overall debt. Instead of this you simply pay off the level of interest that you have on your loan.

This means that monthly repayments are often around half as much, or less, than they would be if you took out a more traditional type of mortgage deal.

On an interest only mortgage you are not paying off any of your overall debt, only the cost of taking out the loan that is charged by the lender. This means that at the end of your mortgage's term you still have the total amount of debt left to pay off. Normally this is done through what is known as a "repayment vehicle". A repayment vehicle normally comes in the form of some sort of investment scheme such as an ISA or another form of saving. If you can't afford to pay off the amount that is still outstanding on your debt, you will have to sell your home in order to pay it back.

Costs of interest only mortgages

Interest only mortgages cost less per month than a full repayment mortgages due to the fact that you only need to pay back the interest on the loan each month. However interest only mortgages do end up more expensive over the lifetime of your mortgage because even though monthly payments are lower, the amount of interest that you pay each month will be higher.

This means that the attractiveness of lower monthly repayments is often outweighed by the bigger financial strain that this type of mortgage will place on you in the long run. Generally speaking if you want to lower the cost of buying a house, then you are better off going for a standard repayment mortgage than you are by choosing an interest only mortgage.

Can I get an interest only mortgage?

Due to the fact that interest only mortgages can represent much more of financial burden in the long run, there are stricter regulations upon lenders who offer them. This is to avoid consumers being landed with debt that they cannot handle and being caught out by what looks like a good offer on the surface.

The Financial Conduct Authority (FCA) have put strict laws into place that ensure that force lenders to make sure that the person taking out a loan can afford to repay the debt in full at the end of the term. The mortgage provider must also make sure that they have assessed the income and spending of an individual to ensure that they could manage payments should interest rates rise.

Buy-to-let mortgages

When somebody takes out a buy-to-let mortgage it is almost always an interest only loan. These types of loans are considered to be business loans as opposed to mortgages and are therefore not subject to FCA regulations that apply to mortgages. These types of mortgages are assessed by examining the amount of rent that the mortgage holder could stand to charge, that could then be used to pay off the loan in the long run.

What else are interest only mortgages used for?

People often take out interest only mortgages in areas that rent is particularly high. This is because the interest on the mortgage can often work out to be cheaper. This allows people to get a foot on the property ladder, however it is advisable to switch to a repayment mortgage as soon as possible to avoid being stuck with a huge debt at the end of the mortgage term.

Some people also decide to take a gamble on house prices going up to higher than the value of the mortgage during the term. If this happens you can sell the property, pay off the debt and even take home a little bit of profit. However if your gamble fails and house prices go down, you will still need to pay off the amount of debt that you borrowed initially. For this reason it can be a very risky strategy.