Interest only Mortgages – A Complete Guide
Some borrowers may seek out alternative mortgage repayment methods that allow them to repay the principal amount later. One such option available to every eligible borrower is the interest-only mortgage.
How Do Interest-Only Mortgages Work?
Interest-only mortgages are loans that require you to pay just the interest for an agreed time frame. Once that period elapses, the loan will either revert to the conventional amortisation plan, requiring you to pay both the principal payment and interest, or you will need to repay the debt.
You may decide to pay the principal during the interest-only period, but this is not a condition for applying for interest-only mortgages. Usually, lenders offering interest-only mortgages have stricter requirements and will most likely need you to prove you can repay the entire loan amount in future.
Retirement Interest-Only Mortgage
A retirement interest-only (RIO) mortgage is very similar to an interest-only mortgage. The main difference is that RIOs are available to older borrowers over 50 and can only be secured against your primary residence. Also, you don’t have to repay the principal amount until you die, move into long-term care, or sell the house.
So, retirement interest-only mortgages are loans secured against your main residence that require you to pay only the monthly interest throughout the loan term. You only repay the principal when you sell the property or when the last borrower dies or moves into permanent long-term care.
Unlike standard residential mortgages, you don’t have to prove that your income can repay the loan with RIOs. You only need to prove that you can pay the monthly interest. Hence, RIOs are the best interest-only mortgages for older borrowers. It’s always best to speak with a broker to get the best retirement interest-only mortgage rates.
Retirement interest-only mortgage is similar to an interest-only lifetime mortgage. The primary difference is that you can revert to the standard lifetime mortgage and accrue the interest rather than paying monthly. But for RIOs, you cannot do so. You must pay interest monthly on your mortgage.
What are the Differences between Interest Only and Repayment Mortgages?
The difference between interest-only and repayment mortgages is how you pay for your loan. For interest-only mortgages, you only pay the monthly interest for a specified number of years before repaying the loan. On the flip side, repayment mortgages require paying part of the loan and the interest monthly till the mortgage term ends.
Since you are paying both the principal and interest for repayment mortgages, monthly repayment will be higher than interest-only mortgages. However, your equity will increase monthly because you also pay part of the loan. But for the interest-only mortgage, you won’t pay off the loan for some years, and you may be unable to pay it off at the end of the loan term.
Also, the criteria for interest-only mortgages are usually stricter than repayment mortgages. Typically, you may need a lower loan-to-value ratio, so you may have to provide a higher deposit on the house. Interest-only mortgages also require a higher income bracket than repayment mortgages.
Advantages & Disadvantages of Interest-Only Mortgages
Advantages of Interest-Only Mortgages
The benefits of an interest-only mortgage include the following:
- Lower Initial Monthly Payments: You get to make lower monthly payments throughout the interest-only period, as you will pay only the interest. Hence, this mortgage type is suitable for borrowers who want to make lower initial payments on their mortgage.
- You Can Pay Equity on Your Schedule: Most mortgage providers will allow you to pay part of the loan alongside the interest. So, you can pay equity conveniently within your interest-only period.
- Tax Deductions: The interest paid monthly is a tax deduction, so if the value of your home increases before you pay the principal, you can save more.
- It May Help You Afford a Pricier Home: You can apply for an interest-only loan to purchase a pricier home you currently can’t afford. This can be a great option when expecting an income increase within a few years, meaning you can repay the principal after the introductory period.
- Increased Cash Flow: You can keep more money for your monthly expenses. Since you make cheaper monthly repayments, you have more cash flow within the introductory period.
Disadvantages of Interest-Only Mortgages
- No Equity Growth: Taking an interest-only mortgage means you won’t pay the principal amount for a specified period. Hence, your equity on the property will not increase during that period. For instance, if you take a 10-year interest-only mortgage, your equity will not build up for the first ten years of your loan term.
- Higher Interest Rate and Deposit: Usually, mortgage lenders could demand a higher interest rate and higher down payment, making interest-only mortgage rates higher. This could make it more challenging to qualify for such loans.
- You May Pay More: The loan value doesn’t reduce over time because you are only paying the interest. As a result, you may end up paying more interest on the mortgage than you will with a repayment mortgage plan.
Is an Interest-only Mortgage suitable for me or not?
Generally speaking, a repayment mortgage is more affordable and convenient than an interest-only loan, so interest-only mortgages are unsuitable for most borrowers. However, it is an ideal option if you want to reduce your initial monthly remittance, but you must remember that doing so will increase your later payments. So, if you can afford the monthly amount for a repayment mortgage, it’s better to go for it.
An interest-only mortgage is most suitable for a buy-to-let interest-only mortgage. This mortgage option allows you to get more houses and resell them later to pay the loan. Also, you can consider interest-only mortgages if you need funds to invest elsewhere. Paying only interest will buy you enough time to pursue other investments.
Another situation where interest-only mortgages are beneficial is when you want to buy a holiday home. You can also apply for an interest-only mortgage to buy a holiday home.
Older borrowers can also consider retirement interest-only mortgages, which are interest-only mortgages for those over 60, as an alternative to conventional residential ones.
If you have yet to decide if an interest-only mortgage is the right fit for you, we are here to help.
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How Can I Apply for Interest-Only Mortgages?
Consulting a specialist broker with experience in interest-only mortgages will improve your chances of getting the best interest-only mortgages. They will compare the current interest-only mortgage rates UK to find the best deal for you. Your broker will also help you prepare the necessary documents and check your credit history.
Do you want to apply for an interest-only mortgage? Let’s help you find the best interest-only mortgage rates.
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Acceptable Payment Strategies for Interest-Only Mortgages
There are different options available when repaying your interest-only mortgage. However, the most suitable repayment vehicle depends on your lender and your personal circumstances. Here are the acceptable payment strategies for interest-only mortgages:
- Endowment Policies
This strategy involves paying a monthly premium to an insurance company to receive a lump sum on the day of maturity or when you die. This sum will be used to repay your mortgage.
However, there is no guarantee that the amount received will be sufficient to repay the loan fully, so some lenders shy away from endowment policies. It’s still possible to find lenders willing to consider this option, but you must prove realistic growth rates that will yield enough output to pay off the loan.
If you are nearing retirement, you can use your pension as a repayment vehicle for your interest-only mortgage. While you pay interest to the mortgage provider, you will pay a premium to the pension provider for your pension plan. When using this repayment strategy, you must provide evidence that the predicted value of your pension can cover the interest-only mortgage.
Are you nearing retirement? Contact us now for your pension advice.
When remortgaging, you move your mortgage to another lender by taking out a new one to pay off the previous one. This strategy helps you repay your interest-only mortgage and take out a new mortgage. It can also be ideal when you can’t repay your loan at the end of the term.
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- Stocks and Shares ISA
You can use your savings in a stocks and shares ISA (individual savings account) to repay your interest-only mortgage. When you fund your ISA monthly, you can use the savings to repay your mortgage at the end of the term. But there is no assurance that your ISA savings will be sufficient to repay the mortgage.
Typically, the mortgage lender will require your ISA statement to calculate the estimated value. However, not all lenders accept stocks and shares ISA as a repayment vehicle.
- Selling Your Property
You can choose to sell your property to pay off the debt. This option is popular with buy-to-let interest-only mortgages and RIO mortgages. Homeowners who buy to let can sell off the property at the end of the term after making a profit from letting the property. Also, older borrowers taking out RIO mortgages usually repay their loans by selling the house when they die or move into long-term care.
What will happen if You can’t Repay the Mortgage?
Several options are available if you can’t repay your mortgage when your term ends. You may choose to sell the property to repay the loan. But if the money from the sale cannot cover the loan, you will provide the balance.
However, if you don’t want to sell the property, you can ask for an extension on your term length. Doing so will buy you more time to come up with the repayment. Unfortunately, not all lenders offer extensions, but it is best to seek one sooner rather than later to improve your chances of approval.
You can also consider remortgageing to pay off the current loan. Older borrowers over 55 can choose equity release to get a tax-free lump sum against their property to pay off their mortgage.
Interest-only mortgages allow borrowers to pay only the interest on the loan. The interest-only mortgage option is suitable for borrowers seeking cheaper monthly payments, buy-to-let investors, older borrowers, and those buying holiday homes.