What is an interest-only mortgage and how does it work?
With an interest-only mortgage, you will only be required to repay the interest element each month, not any of the original capital borrowed. Assuming you’ve not made overpayments, the mortgage balance will remain exactly the same when the mortgage term ends, and you’ll need to find a way to repay the mortgage or sell the property. The monthly payments will be lower than those on a capital repayment mortgage.
Almost all interest-only mortgages require a minimum 25% deposit for a purchase or equity in the property for a remortgage. Some lenders insist on a deposit higher than 25%.
Some lenders require minimum incomes for interest-only, for example, £75,000 for sole applicants or £100,000 for joint applications, however, there are lots of lenders that do not have minimum incomes.
How to work out the monthly payments on an interest-only mortgage?
The calculation to work out the monthly payment is fairly straightforward because it’s just the interest payable on the total sum.
For example, if you borrow £100,000 on a 3 percent mortgage, your annual interest would be £3,000, therefore your monthly payment is £3,000 divided by 12, which is £250 per month.
What happens at the end of an interest-only term?
When your mortgage term comes to an end, you’ll be expected to repay the total amount borrowed. Your lender will usually write to you 6 months in advance of your term ending. You will need to repay the mortgage somehow, either by selling the property, using savings, or taking out another mortgage (remortgaging).
Your repayment options
When arranging an interest-only mortgage, the lender will insist on you having a suitable repayment vehicle to repay the mortgage at the end of the term. Lender’s criteria will differ on what they deem an acceptable repayment vehicle.
Typical repayment vehicles might be:
Selling the mortgaged property
Some lenders may accept the sale of your main residence as a repayment vehicle if there is sufficient equity in the property to repay the mortgage.
Selling a different property
If you own another property in addition to the one you are mortgaging, some lenders may allow you to use the sale of the second property as a method of repayment.
Savings, stocks, bonds, or a pension fund could also be viable sources for you to use to make the repayment.
So long as you clear the mortgage on or before the end of the mortgage, it does not matter if you repay the mortgage with different funds from those stated as your original intended repayment vehicle.
Can you make overpayments on an interest-only mortgage?
Just like on a capital repayment mortgage, overpaying on an interest-only mortgage is certainly possible. You will need to check the early repayment terms with your mortgage provider. Most fixed-rate mortgages will allow 10% of the mortgage balance to be cleared annually without penalty during the fixed-rate period, however, this does vary amongst lenders.
The overpayment would reduce the capital amount owed and the monthly payment amount.
What happens if you can’t pay off the mortgage at the end of the term?
If you’ve reached the end of the mortgage term and do not have the ability to repay the loan, you could sell the property to repay the mortgage. If your preference Is not to sell the property, the following options are worth exploring.
Extend the mortgage term
Your current mortgage provider may be willing to extend the mortgage term. However, with most interest-only mortgages, you will be unable to borrow past age 70, however, some lenders will consider 75. They may insist on re-underwriting the case based on your current situation. If your existing lender is unable to help, you may be able to look with other lenders.
Switch to a repayment mortgage
If you can afford the increased mortgage repayments, it may be worth switching to a capital repayment mortgage, this may be with your existing lender or via remortgaging to another lender.
Capital repayment mortgages can usually be taken over longer terms or until a greater age and can sometimes be arranged on a part repayment part interest-only basis to help lessen the impact.
Can I switch from interest-only to repayment?
Yes, you can move your interest-only mortgage to repayment. It’s worth seeking advice from a mortgage broker to discuss your options. This may involve a credit check and affordability assessment.
Benefits of interest-only
The main benefit of an interest-only mortgage is that your monthly payments will be cheaper. If you are buying your own home, an interest-only mortgage may help you to afford a more costly property than you otherwise could.
Downsides of interest-only
The biggest drawback is that you will not clear any of the capital and will need to find another way to repay the mortgage. Because the capital is not decreasing, there is also a greater risk of negative equity if property prices were to fall significantly.
Is an interest-only mortgage best for buy-to-let?
The most popular use of interest-only is for buy-to-let landlords. Most landlords opt for interest-only to keep their overheads low. The property is viewed as an investment and, therefore, can be repaid when they sell the property.
How can Strive Mortgages help?
Deciding whether to choose capital repayment or interest-only is a big consideration, and is worth discussing your options with a qualified mortgage broker with experience arranging interest-only mortgages.