There are two ways of repaying your mortgage loan, repayment mortgages and interest only mortgages. Interest only mortgages mean that each mortgage payment is used to pay off only the interest on the mortgage loan.
Usually, borrowers on interest-only mortgages will also take out a form of repayment vehicle to ensure that the capital of their mortgage can be paid in the future.
How do interest only mortgages differ from repayment mortgages?
Interest only mortgages mean that the monthly repayments do not pay any of the outstanding mortgage balance, the capital. Interest-only mortgage repayments are therefore likely to be lower.
When the mortgage reaches the end of the term, it is essential that a repayment vehicle is in place to cover the capital. There are various types of repayment vehicle.
What types of repayment vehicle are linked to interest only mortgages?
A variety of repayment vehicles may be linked to interest only mortgages. These can include endowment mortgages, mortgages linked to ISAs and mortgages linked to pension plans. Borrowers with significant assets, high-paying professional jobs or large savings may not need a repayment vehicle.
How popular are interest-only mortgages?
It is thought that millions of borrowers in the UK have interest-only mortgage loans, with many having no repayment vehicle.
This level is rising, and when the market suffers many borrowers seek to remortgage to an interest-only mortgage to lower repayments. Many first-time buyers who struggle to afford their mortgage choose interest-only as a payment method.
Do lenders need proof of repayment to lend interest-only mortgages?
In the past, a repayment vehicle was essential in order to borrow interest-only. However, most lenders may not require proof of repayment.
Recently, mortgage lenders have simply alerted borrowers with a reminder on each annual mortgage statement.
Are some people facing a problem with interest-only mortgages?
It is thought that in the UK as many as three million homeowners are not making any provision to pay off their mortgage. In a climate of rising house prices, this can be financially successful.
However, if house prices stall or fall, the potential for financial disaster very quickly looms. If house prices fall, negative equity is a real and unpleasant possibility for interest-only mortgage holders with no repayment vehicle.
Interest Only Mortgages: Advantages & Disadvantages
Interest only mortgages, along with tracker mortgages, are enjoying prolonged media exposure in the current economic climate. Many are enticed by interest only mortgages as this often allows for cheaper repayments when compared to repayment mortgages.
However, it is essential to understand the possible disadvantages of interest only mortgages before any decision is made, as this could lead to debt.
What are the advantages of interest-only mortgages?
There are some advantages to interest-only mortgages. These include:
- Possibility that the borrower will profit from a repayment vehicle.
- Some repayment vehicles are also tax efficient.
- Although the medium and long-term effects of interest-only mortgages must be considered, in the short term interest-only means lower repayments.
What are the disadvantages of interest-only mortgages?
- With interest-only, the borrower owes the same at the end of the loan as he or she did at the start, only the interest has been paid off.
- One of the disadvantages of interest-only mortgages is the potential for the repayment vehicle to not achieve the projected amount, therefore leaving a shortfall that the borrower must pay off to clear the loan.
- Any shortfall on the mortgage capital is the responsibility of the borrower. This has been a major problem with endowment mortgages, and has lead to them falling completely out of fashion.
- Checking the repayment vehicle regularly will allow the borrower to ensure this does not happen.
- The interest-only disadvantages will depend on the repayment vehicle, and this should be well understood and clearly discussed before a mortgage is committed to.