Interest-Only Mortgages: Dos and Don’ts

In the years running up to the credit crunch the popularity of interest-only mortgages soared, as borrowers were able to cut their monthly repayments by just paying back the interest, not the capital. By the end of 2012, most lenders stopped lending on an interest-only basis, after many within the industry deemed it irresponsible.

However, according to latest figures from the Council of Mortgage Lenders, around 1.9 million buyers are interest-only mortgage customers. For many first-time buyers or homeowners who may be ready to remortgage, understanding the options available and the best to suit their needs and financial state isn’t alway’s easy.

That’s why we have put together a breakdown to help buyers understand the ‘do’s and don’ts’ of interest-only mortgages, who they could benefit and the risks of lending on an interest-only basis.

What Does ‘Interest-Only’ Mean?

An interest-only mortgage offers buyers a cheaper way to buy a property. This is due to the repayments only covering the interest of the loan, rather than paying off the capital.

By the end of the mortgage term agreed, the buyer will only have paid off the interest of the original loan and nothing of the actual debt, unlike a repayment mortgage that would have cleared the debt.

Why People Chose Interest-Only Mortgages?

For both first time-buyers and next-time buyers, particularly those who may be buying in high-price area’s such as London and the South East, interest-only mortgages can sometimes be cheaper than renting.

Often, buyers do have the intentions to switch to a repayment mortgage at a later date, but many get used to the lower repayments and put off increasing the amount, meaning the cost continues to mount.

What Are The Risks Of Borrowing On Interest-Only Terms?

One thing to bare in mind when considering an interest-only mortgage is trends in market. For instance, if house prices don’t rise, buyers will not gain any equity in their home, which essentially means they renting, simply from the bank. So switching from interest-only as soon as possible is advised.

Can Interest-Only Borrowing Work For You?

If you are a buyer and are considering lending on an interest-only basis, there are a number of things that you should bare in mind before making a firm decision:

Be sure that you can afford more than the initial interest-repayments each month. This will help you when you come to switch to a repayment-mortgage and the monthly cost increases.

Put aside a separate amount each month to invest into an Isa or stocks. This will help you save money to go towards paying of the capital of your mortgage. It’s also much better to have this when it comes to switching, as you could struggle if your interest rate goes up.

Check if your lender will allow you to may overpayments. Any sum you pay off is then no longer covering interest, but going towards the capital.