Interest Only Mortgages Made Simple
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Interest-Only Mortgage
Adam Messer explains interest-only mortgages, how they work and the pros and cons.
What is an interest only mortgage and how do they work?
An interest only mortgage is just like any other normal mortgage. It’s A nice big loan from a bank or building society, secured on your property.
But with this kind, you’re not repaying it over time – which is the traditional approach with a mortgage. The standard way is to borrow an amount, make a monthly payment and after 25, 35 or what seems like 60 years, it’s paid off. It’s done and you own the house outright.
An interest only mortgage is different. You’re still making a payment each month but you’re only paying the interest – so the balance never actually goes down. The monthly payment is smaller but stays consistent through the term, because the amount you owe doesn’t go down. You still owe as much at the end as you did at the start.
There are lots of different scenarios for why you might want to do that, which we’ll come on to. But those are the basics.
What’s the difference between interest only and capital repayment mortgages?
With a capital repayment mortgage – capital and interest you might call it – you’re repaying the loan over a set period of time. With interest only, you’re just covering the interest.
Are interest only mortgages widely available?
Yes, most high street lenders and some specialists will offer an interest only option, but a lot will have certain criteria you have to meet.
Some lenders set a minimum income. Some will prefer certain repayment methods or ‘repayment vehicles,’ which is how you’re going to repay the mortgage at the end. That might be the sale of this property or other property. If you’re buying a property now and plan to downsize in however many years, the lender will want to make sure that you’ve got enough equity in that property to do that.
So these mortgages are available – I’m not sure I’d say widely. And they’re not right for everyone.
Who qualifies for an interest only mortgage?
Anyone could qualify. At the time we’re recording this, in late November 2023, as long as you’ve got about £25,000 equity in your property and your mortgage doesn’t go beyond age 70, you can take your mortgage on interest only up to 50% of your property’s value.
For example, you could have a house worth £500,000 with a mortgage of £250,000. You have £250,000 equity, so you could have an interest only mortgage up until you’re 70 if you want one.
If you want to borrow more than that, or you have more equity, you could do ‘part and part,’ where some of your mortgage is interest only and some of it is repayment.
There are other qualifying factors as well. If you want a broad choice of lenders, we might need to meet a minimum income, which could be £75,000 or even £100,000 with some lenders.
They really want to make sure you know what you’re doing and that at the end of the term you will have somewhere to live – because they will want their money back. They do have to be a little bit careful about who they’re giving interest only to.
Why would you have an interest only mortgage?
Buy to Let is almost always interest only. But with residential property, the main – and worst – reason is because you want to keep your repayments low. It’s the worst reason because realistically, should you really have that mortgage if you can’t afford to repay it? What’s going to happen at the end of the term? How will you repay it then?
We do often help people with interest only mortgages. An example is where you’re buying a property now that is big enough for the whole family, but in 10 or 15 years time you’ll be able to sell it and downsize. You’ll have a good chunk of equity and you can move to a smaller property and repay your loan with the proceeds of the larger house.
What documents are needed to apply for an interest only mortgage?
It’s the same as any other mortgage – proof of income from payslips or tax documents. It will depend on how you’re employed. You will also need ID and bank statements.
With interest only the repayment strategy is the most important thing – how are we going to repay the mortgage at the end? If you will use an investment or another property, we need documentation to show the lender that money, or that it’s growing.
Some lenders have an extra form to sign, confirming you’re not repaying any of the balance of the mortgage and you’re happy to owe as much at the end as you do now.
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What happens at the end of the interest only period?
You need to pay it back. The lender will write to you to remind you that the mortgage has ended, or is ending soon, and that they need the money back.
Some people get into trouble at this point because they haven’t got a plan in place. The house needs to be sold. I’ve helped people in this situation before – the lender’s not suddenly going to take the house from you, as long as you’re maintaining the interest payment. They won’t leave you alone indefinitely, but if you are communicating your plan with them that helps.
Repossessing your home would be unfair, because you don’t owe them. You’re not behind on the payments, but they will want to know how you will pay it back.
What are the pros and cons of an interest only mortgage?
The pro is a lower monthly payment. But that’s also a con – because you’re not paying the mortgage off. Most people want the reassurance that they’re paying their mortgage off.
You need to have something in place that will repay the mortgage at the end. It might just be the equity in your home, or something else.
How much are interest only mortgage interest rates?
I’m not going to give particular rates today because it will probably be different by next week. But generally speaking, the lenders don’t have certain rates for interest only and other rates for repayment.
If you meet a lender’s criteria, you’ll get their set rates, whether it’s interest only or repayment.
How do you calculate interest only payments? Can an interest only mortgage calculator help?
We don’t need a mortgage calculator for this one. It’s a simple calculation. You just take your loan amount, multiply it by the interest rate, divide it by 12 and that’s your monthly payment.
Let’s say you’re borrowing £200,000 on interest only at 4% – that’s just a made-up rate. Multiplied, that’s £8,000. Divide that by 12 and it gets to £666 per month.
On a repayment mortgage the payment will be higher because you’re factoring in repaying the mortgage. The longer the term of the repayment mortgage, the less difference there will be.
Let’s say you just need a small mortgage and you’ve got a lot of equity but you just need a mortgage for a little while. If you’re 60, wanting a 10 year mortgage for £200,000, that’s going to be a big monthly payment. But just covering the interest will be more affordable, as long as you have a plan to repay it.
Can I change my interest only mortgage to capital repayment – or vice versa? Is there a charge?
You might be able to change. There’s a thing nowadays called the Mortgage Charter – how long that’ll be around for, I don’t know. But if you are struggling to pay your mortgage, your lender may allow you to just pay some interest for a few months.
If your lender doesn’t like doing interest only or if you don’t meet their interest only criteria, you’re not going to be able to change.
It’s usually easier to change from interest only back to repayment, because lenders like to see you repaying. There are some things to be aware of. For example, some lenders calculate affordability in the same way as they would on a repayment mortgage over 25 years.
If you’ve only got a 10 year mortgage, for example, you’re borrowing the amount that you would be able to afford over 25 years. So if you’re 60 and can’t have a 25 year mortgage, they may say that you can’t change to repayment because you can’t afford the repayments over 10 years.
It might not be possible to swap with your current lender, but another lender out there might do it. It’s not really a clear cut answer. But it is possible to change, depending on your lender and which way round you want to change.
There wouldn’t usually be a charge unless you need to switch lenders, in which case you might have a penalty to come away from the lender you’re with.
Can I pay off an interest-only mortgage early?
Yes, like any mortgage you need to factor in any early repayment charge. If you’re midway through a fixed rate or a tracker rate – we call it a discount period rate – you’re probably going to have a penalty. That’s the same with any mortgage.
Is it possible to increase my interest-only mortgage term?
It depends on the lender and your situation. Whether you’ve got a five year mortgage or a 35 year mortgage, it’s not going to affect your monthly payments – you’re just paying the interest. So you wouldn’t need to worry about what your term is.
It becomes relevant where you’ve got a few years left on an interest only mortgage and haven’t got the money to repay it. In this case, it again depends on the rest of your circumstances – your age, income, your equity and if there are any other options for you. So speak to a mortgage broker if you need to do that.
What if I can’t pay at the end of my term or don’t want to sell my home?
You might not get much choice in the end. This is something that would potentially happen later in life. You can take an interest only mortgage up to age 70, and some specialist lenders might go longer than that.
There are other options for you, depending on your age and how much equity you’ve got. You could look at equity release, which is another form of interest only mortgage. You can maintain the payments If you’re happy to, or let the debt roll up.
With equity release, the older you are, the more you can borrow – it’s all about how much equity you’re going to use up in your home. It’s a big subject for another day.
What if I’m struggling to meet the mortgage payments?
If you’re struggling to meet your monthly payments on interest only, the only thing that’s going to help you is borrowing less. To borrow less you would need to sell the house and buy a smaller one.
You could perhaps change the interest rate, but if you’re already on a normal interest rate and you’re struggling with those monthly payments, there isn’t really much else you can do to make them lower – other than borrowing less by downsizing.
Can I get an interest only mortgage with bad credit?
As with any element of bad credit, it depends what it is, how much it is and how recent it is. There are lenders we can go to for interest only with bad credit. Whether you will qualify for that, we would have to see individually. But yes, potentially.
Can you get a Buy to Let interest only mortgage?
Yes, most Buy to Let mortgages are interest only. I can’t remember the last time I did a repayment one.
Generally landlords want to just cover the interest. You never need to repay a Buy to Let – some lenders will give you a Buy to let mortgage until you’re dead. It’s tricky to get your head around if you’re new to these mortgages – we’re all programmed to repay so the mortgage is gone by the time you retire. But that’s not the case with Buy to Let.
With a Buy to Let mortgage you can be better off not repaying it and putting the money into buying more property – but that’s more of a conversation for another day.
What should I do before applying for an interest only mortgage? Should I get advice?
Definitely, always. You need advice from a mortgage broker because you need to think carefully about whether interest only is right for you.
In certain situations it’s absolutely the right thing to do, but it’s not for everyone, so we need to be careful about why we’re doing it and who for.
How do you qualify for an interest only mortgage?
There are so many different factors to qualify for an interest only mortgage. Your income is one thing – but not with every lender.
You will certainly need a repayment vehicle to repay the mortgage at the end of the term – whether that’s equity, other investments or savings. Then we know that at the end of the term the mortgage can be paid off. That’s the criteria, basically, and that’s what we need to think about in deciding if interest only is right for you. The best way to do that is by speaking to a mortgage broker.
Your home may be repossessed if you do not keep up with your mortgage repayments.
The Financial Conduct Authority does not regulate most Buy to Let Mortgages.
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