Interest-Only Mortgage Guide – Pro’s, Con’s & Where To Find One

If you’re thinking of taking out an interest-only mortgage, read on to find out the pros and cons of this type of mortgage, and where to find one.

During their heyday in the 80s and 90s, interest-only mortgages were said to account for eight out of every ten new mortgages. Having fallen out of favour by the millennium, interest-only mortgages are now making a big comeback, and more people than ever are keen to find out about the pros and cons of this type of borrowing and where they can find an interest-only mortgage.

Interest-only mortgages can provide hopeful homeowners with a much easier way to get their foot on the housing ladder, with cheaper monthly payments making this seem like a much more manageable and affordable option for many. As you are only repaying the interest on the loan you have taken out and not the capital, this type of mortgage could be ideally suited to those with larger incomes or those interested in buy to let.




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What is an interest-only mortgage?

With an interest-only mortgage, the borrower only repays the interest they owe their lender, rather than paying off the capital they have borrowed against their property. This means that by the time the policy comes to an end, the interest will have been paid off but the original debt will still be outstanding.

In the past, interest-only mortgages have often been sold in combination with an endowment policy, which was used to pay off the main mortgage debt at the same time as the interest-only mortgage was paying off the interest. As endowment policies did not perform well and soon fell out of favour with borrowers, interest-only mortgages have increasingly been seen as a way for those struggling to afford repayment mortgages to make the first step towards homeownership.

 

Repayment mortgage or interest-only?

The two main types of mortgage offered by lenders are interest-only mortgages and repayment mortgages. Capital repayment mortgages mean you pay back the full amount you have borrowed over the course of the fixed term of your mortgage, which is usually set at twenty-five years. The monthly payment that the borrower makes contributes to paying off both the capital and the interest accrued. Over the first few years, the majority of the monthly instalments will be used to pay off the interest, with only a small portion going towards the capital, but over time, the balance will shift until the debt has been repaid in full.

With an interest-only mortgage, you only pay off the interest, and by the end of the mortgage term, the capital is still owed and you will need to arrange another method of repaying this main debt. This means that you make a smaller contribution each month, but by the end of your fixed period, you are still left with a sizeable portion of your debt still outstanding.

 

The advantages of an interest-only mortgage

The most obvious advantage of an interest-only mortgage is that the monthly repayments are much smaller. This can work out well for those on limited incomes, who want to get a foot on the housing ladder, but may not be able to afford the higher costs of a repayment mortgage. They can also work well for those on higher incomes or those who have enough money saved away to pay off the capital owed. For those interested in buy to let, an interest-only mortgage can be a sensible option, as the rent paid by tenants can be used to pay off the interest, whilst the borrower is free to save up enough to pay off the capital.

There’s always the possibility of taking out an interest-only mortgage for a shorter period of time, perhaps switching to a full repayment mortgage once you have assessed your financial situation a few years down the line. This can be a good way of starting to repay your lender before you become fully committed to larger monthly repayments.

 

The downside of an interest-only mortgage

There are, of course, risks to taking out an interest-only mortgage. The main gamble is that if house prices do not rise during the term of your interest-only mortgage, you won’t gain any equity on the property, so that you are, in effect, renting your home from the bank.

There’s also the fact that at the end of your mortgage term, you still have to find a way to pay off the capital, so while there are short-term advantages in lower monthly instalments, you’re still left with a sizeable debt at the end, and this could impact on any inheritance you are able to leave. As a last resort, you may be forced to sell off the property in order to cover the debt.



Making the right decision

There are a number of major lenders offering interest-only mortgages, so it is well worth doing your homework and looking around online for the best deals. Among the top offers are an interest-only mortgage from HSBC, which currently offers a two-year, fixed-rate interest only mortgage with an initial rate of 1.14% and an APRC of 3.5%. The maximum Loan to Value (LTV) is 60%.

Post Office Money is offering a competitive two-year, fixed-rate policy with an initial rate of 1.17%, 4% APRC and a maximum LTV of 60%. With a larger LTV of 75%, Natwest offers a two-year fixed loan with an initial rate of 1.42% and a 3.6% APRC.

Before you decide whether or not an interest-only mortgage is right for you, it’s important to do your sums and shop around for the best deal for your circumstances. An interest-only mortgage is a gamble which can pay off and certainly allows you a faster and cheaper way to step onto the housing ladder, but it’s always worth seeking financial advice before making such an important decision.

 

 

Disclaimer: TheMoneyDaily’s service is not intended to be, nor should it be construed as financial advice. We help our readers make informed decisions and can introduce you to comparison services and provide impartial information and guides. Where appropriate, we may introduce FCA authorised partners who can provide services relating to financial products.

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