Interest-only mortgages are mortgages where you only make capital repayments during the mortgage term and then you will have to repay the capital borrowed in one lump sum at the end of the mortgage term.
The mortgage affordability requirements for interest-only mortgages are much more stricter due to the large capital repayment attached to them. In this brief guide we will go over some of the capital repayment methods used and approved my mortgage lenders.
The difference between interest-only mortgages and repayment mortgages
Repayment mortgages have monthly repayments which consist of both the capital borrowed and interest. Interest only mortgages have monthly repayments which consist only of the interest and no capital repayments. This is because the capital is repaid at the end of the mortgage term in one lump sum. The mortgage lender will want to see a credible capital repayment plan and approve it before you will be accepted for an interest-only mortgage.
Interest-only mortgages are used mostly for investment purposes such as the buy to let properties as investors weigh the cost of interest repayments (which are substantially smaller than having a repayment mortgage) with the expected gain in property appreciation.
Since 26 April 2014 mortgage lenders have had to put repayment plans under greater scrutiny and conduct a full affordability assessment with evidence of income.
This means that if you took out an interest-only mortgages taken out before 26 April 2014 then you might find it difficult to get another mortgage.
You can use our interest- only mortgage calculator to see what your monthly payments will look like.
Your interest-only mortgage repayment plan
A credible capital repayment plan will need to be in place before the mortgage lender will agree to give you an interest-only mortgage. The mortgage lender must agree with you that your repayment plan will work and it is your job to explain it to them in a way that makes it clear and easy to understand.
Relying on money that may or may not come in the future such as inheritance is likely not going to suffice.
You can also not rely on property prices appreciating as the mortgage lender will not view this as a credible interest-only mortgage repayment plan.
Borrowers will usually aim to use the equity they have gained from capital appreciation to repay the interest-only mortgage but this again is simply hoping and wishing and will not be viewed as a credible repayment plan.
A capital repayment plan is good but a good budgeting tool or app will keep you on track for many months to come.
Some of the widely accepted interest-only repayment plans
- Existing cash
- Existing unmortgaged properties or mortgaged properties with a minimum equity level
- Stocks and shares ISAs
- Unit Trusts
- Saving accounts( cash in a savings account. Not all lenders might accept this.
- Endowment policies
It will be totally up to your interest-only mortgage lender to accept or refuse your repayment plan, even when it seems completely feasible an credible to you, it might just not fit the lenders criteria.
You should definitely seek independent financial advice.
Risks of interest only mortgage
Getting an interest only mortgage has some very serious risks
If interest rates go up your monthly repayments will go up and you can find yourself not being able to keep up on your repayments. The mortgage lender will usually stress test yourmortgage affordability before approving the mortgage.
If house prices fall or interest rates go up significantly you may find yourself owing more on the property than it is worth. This is called negative equity.
Your investments could pose a significant risk if they are your chosen repayment method. You should always have the option to move your investments to more cash based products if you begin to lose confidence in your investments. This will ensure you have funds to cover your interest-only mortgage capital repayment at the end of your mortgage term.
If you already have an interest only mortgage then you should regularly review your repayment plan to ensure it is inline with your expectations and still performing accordingly.Your mortgage lender might write to you once in a while to ensure you still have a credible repayment plan.
If your interest-only mortgage repayment plan isn't working and you aren't sure you will have enough money to pay off your interest-only mortgage here are the steps you should take:
Get a report from your investment or fund manager on how far off track you are and what the future outlook is like from their professional opinion
Review your other assets to see if you will be able to cover any shortfall in the investments with other funds or assets you have
Contact your mortgage lender and inform them of the situation.
Inquire with your mortgage lender on if you will be able to switch to a capital repayment mortgage or pay off some off the capital owed in lump sums.
You should check if the mortgage lender can make it part repayment and check if there will be any mortgage fee due if you do this.
Your existing mortgage lender can also switch you to a new interest-only mortgage but they cannot increase the amount you initially borrowed.
You can also remortgage to a new mortgage lender
If you took out an endowment policy to pay off your capital and it looks like it won’t pay out enough to repay the mortgage at the end of the term then you should contact your mortgage lender and endowment policy provider.