What Are the Options?There are two different methods that can be used when setting up a mortgage. The first is capital and interest repayment, often referred to simply as a repayment mortgage. As the name suggests this repayment method means that the monthly payments will cover not only the interest charged on the mortgage but also pay off a small amount of the loan. Over time the mortgage will be gradually reduced and assuming that all the monthly payments are kept up the mortgage will be completely repaid at the end of the term. The second method is interest only where the monthly mortgage payment is only enough to cover the interest charged on the loan. The monthly payments will make no dent in the amount owed on the mortgage balance at all so the loan does not reduce throughout the term.
How Is an Interest Only Mortgage Repaid?The theory with an interest only mortgage is that the borrower also makes a contribution into a separate vehicle that runs alongside the mortgage. As time goes by the contributions will grow until they are big enough to pay off the mortgage at or before the end of the mortgage term.
Repayment vehicles have tended to be investment accounts such as endowments or more recently stocks and shares ISAs. The hope is that the fund will grow more rapidly and reach the point where it will either pay the mortgage off earlier than the end of the term or potentially result in a surplus after repaying the mortgage.
Are There Risks?Any reliance on investment performance will come with risk as there can be no guarantees that the repayment vehicle will grow adequately to repay the mortgage. Years ago many borrowers were mis-sold endowments when these risks were not made clear. When the policy performance fell well short of the projected amount borrowers found that they faced a shortfall on the mortgage amount and consequently had to find funds from elsewhere or extend the term of their mortgage. More recently homebuyers took interest only mortgages but didn't contribute to a separate repayment vehicle. Instead they intended for the property itself to be the repayment vehicle when it was sold. The danger is that the property value does not keep on rising and either isn't enough to repay the loan or would not be sufficient to enable them to downsize to a smaller property.
How Easy Is It to Get an Interest Only Mortgage?The concern over the use of interest only to lower the monthly payment despite the lack of a robust repayment vehicle has led to new, tougher mortgage rules. Lenders have in many cases limited the proportion of the property value that they are prepared to lend on an interest only basis. They are much more restrictive as to what constitutes an acceptable repayment vehicle and in many cases impose limits, such as minimum income requirements.
Some lenders have even pulled out of offering interest only altogether.
Is Interest Only Right for Me?Many borrowers will find it hard to qualify for an interest only mortgage because they have no repayment vehicle in place. Many will not want the risk that can come with it either and as a result the majority of borrowers will prefer the certainty of a repayment mortgage. However it might be right for some, particularly those that already have a repayment vehicle in place and understand the risks that come with interest only. Criteria varies from one lender to another so advice will play a key role in establishing what options are available.
We've teamed up with L & C Mortgages to offer you fee free mortgage advice, head to their website or telephone (0800 923 2045) one of their expert mortgage advisers today to look into your mortgage options.