Interest Only Mortgages

Interest Only mortgages have been a hot topic of conversation in the past few years due to the connection with the mis-selling of endowment policies, but are Interest Only mortgages limited to the tie in with endowment policies, and are they generally a good idea?

Lets clarify, Interest Only mortgage does not necessarily mean Endowment Mortgage. Interest Only mortgage simply means that the mortgage holder pays the interest for the mortgage, but no capital. As an example, if a £100,000 Interest Only mortgage was taken today for a 25 year term, the balance in 25 years would still be £100,000.

There are several options to repay this type of mortgage. Examples include making regular capital overpayments to the loan, using investments such as endowments, ISA’s and cash, or even using the sale proceeds from a property. The vast majority of lenders do not monitor the type of repayment used to repay an Interest Only mortgage, so the onus is very much on the borrower to ensure they have the means to repay the debt when the mortgage term expires.

If the borrower decides to use investments to repay the mortgage, there has to be an acceptance that the value of many investments fall as well as rise. It is therefore sensible to review any investments on a regular basis to ensure they are on course to repay the debt.

In recent years there has been a trend, particularly amongst first time buyers, to take an Interest Only mortgage without any means of repaying the debt at expiry of the term. As no capital is repaid to this type of mortgage, the monthly payments are cheaper. Some borrowers take the view that Interest Only is a stepping stone onto the housing ladder, and a conversion to repayment can be made when they are more comfortable with the higher monthly cost of a capital repayment mortgage. But this course of action is rarely a good idea. Think about the following scenarios.

1) The borrowers become used to paying a low monthly amount for their mortgage, and budget accordingly. Many therefore find the jump to higher repayments difficult and put off the conversion to a repayment mortgage indefinitely
2) If the borrowers are a young couple and circumstances change, such as starting a family, again the switch to repayment is unlikely due to the tighter budget such changes bring.
3) If the property was bought with a small deposit, the chances of negative equity increase should house prices fall and no capital has been repaid from the mortgage.

In the right circumstances, Interest Only can be a very effective method of borrowing money to purchase or remortgage a home, but anyone considering this style of mortgage should seek professional advice before making an application to a lender to ensure they are aware of the risks involved and that a suitable method of repaying the mortgage is planned and budgeted for.

All UK lenders and mortgage advisers need to be regulated by the Financial Services Authority (FSA). Mortgage Brokers are professionally qualified and you should check to ensure that they have the appropriate qualifications

Article by: Chris Baigent 01.08.2008

The articles on this site solely reflect the personal views of the authors and do not necessarily represent the views, positions, strategies or opinions of Smaart Associates Limited. All comments and opinions are made in good faith, and neither Smaart Associates Limited nor the author will accept liability for them.