Interest Only Mortgages

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Interest Only Mortgages

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.

For more information, please see our interest rates guide and how they affect repayments.