Interest only mortgages are not as popular as they once were. Despite this there are still over 700,000 UK properties that have an interest only mortgage.
With this type of mortgage you never actually reduce the mortgage balance through normal monthly payments. Each month you will only be paying the interest that the lender has charged you, hence ‘interest only’. So nothing gets put towards the amount you owe.
But when an interest-only mortgage comes to an end the lender will be expecting you to pay back what you borrowed.
All in one go.
We take a look at interest only mortgages; how they work, who would want one and how you pay them back.
What is an interest only mortgage?
When you borrow money from a mortgage lender they will charge you interest on the amount you borrowed. This is calculated each month based on your outstanding balance. This applies to any type of mortgage repayment method.
With an interest-only loan the lender will only ask you to pay the interest each month, there’s no expectation of extra payments to reduce the mortgage debt. Because of this the monthly repayments are the lowest they can be, making it a popular choice for those on a budget.
However, when the mortgage term comes to an end, the lender will be asking you to repay the loan in full. The payments may interest only but that doesn’t alter the fact that you still owe the same amount you borrowed.
In the example above you borrow £200,000 and at the end of the mortgage term, you still owe £200,000.
Some people who favour the flexibility of interest only mortgages will comment that, due to the effects of inflation, the money you owe at the end of the term is less than the amount you started with. Even though it is the same figure!
There is validity to this argument as over a 25 year period your earnings would have increased, the property price will likely have increased but the debt remains static. Inflation would have eroded the value of the debt.
Our interest only mortgage guide goes into a bit more detail.
So who would want an interest only mortgage?
When you apply for an interest only mortgage the lender will ask you how you intend to repay them. You can’t owe the money indefinitely, it has to end at some point.
These types of loan certainly aren’t suitable for everyone, but they do have a place and are a useful option for many borrowers.
PROPERTY INVESTORS
The most common repayment option for property investors and landlords is interest only.
It keeps the monthly commitments low, increases monthly net income and boosts the yield. Some investors will look to always have a buy to let mortgage, others will sell off parts of a portfolio over a number of years to pay back the debt.
Certainly for property ‘flippers’ this makes perfect sense as the property could well be sold in a few years time.
SHORT TERM BORROWERS
If you only need a mortgage for a short while then choosing interest only probably makes a lot of sense.
This might relate to part of a let to buy arrangement, or even for an expat mortgage where they will return back to the UK in a couple of years.
Bridging loans are always interest only as the maximum term is only 24-36 months.
What happens when the mortgage ends?
When you reach the end of the mortgage you will need to pay back the whole loan amount in full.
During the last 12 months the lender will be writing to you and reminding you of your obligations. If you are unprepared then this is not a time to ignore these letters.
If the debt relates to your home then you would have the option to sell it and then repay the mortgage. But if you wish to continue living there you need to have access to sufficient funds from elsewhere.
Repayment options
When you applied for your mortgage you will have needed to tell the lender your repayment strategy. ie how will you be repaying the loan.
This could have been via sale of a property, an investment maturing, regular savings or perhaps something else. While these plans seemed prudent at the time, many things will have happened over the years to cause them to change.
Where this occurs it is important to re-evaluate your strategy to see if it still makes sense.
Some of the more common strategies are:
Downsizing
When the time comes you will sell your home and move to a cheaper property.
Releasing enough equity to repay your mortgage at the same time.
Property sale
This would be selling other properties that you own, such as a buy to let or holiday let.
Make sure you factor in any tax liabilities.
Investments
If you have been building up a share portfolio or some ISA savings then these can be cashed in to repay the loan.
Sale of business
Upon retirement you may choose to sell your business, and maybe any commercial property owned. This would generate a lump sum to allow you to pay back the mortgage.
Inheritance?
This is suggested by many clients as a means of repaying a mortgage.
While thousands of people each year are gifted money or receive an inheritance when a relative dies, it is not within your control and therefore not guaranteed to happen.
It may never happen at all.
Through no fault of your own things can change:
- new beneficiaries may appear
- long term care fees may deplete the estate value
- poor investment decisions lose money
- changes to the Will affect your expected inheritance
Some time ago endowment mortgages were popular. This involved pairing an interest only mortgage with an endowment savings plan.
The basic idea is that the endowment investment would grow large enough to pay off the mortgage with maybe a bit extra on top.
Unfortunately a lot of endowment mortgages were mis-sold and borrowers were unaware of the possibility that their endowment policy could fall short of the sum needed to repay the mortgage.
It is no longer possible to take out an endowment mortgage.
Keeping your mortgage on track
When you have a capital and interest (repayment) mortgage the lender will calculate your mortgage repayments so that with the very last payment your mortgage is repaid.
With an interest only repayment method you are very much in charge and involved in the process. One of the most important responsibilities is to keep checking that your ‘plan’ is on track.
Now over 20-30 years a lot of things can change and what you thought would happen may not be happening anymore. Things change so your plan has to change and adapt.
Lenders have the legal right to repossess your property if the loan is not repaid as agreed. So if your mortgage is not on track and you are worried about how to pay it back you will need to take some action straight away.
Some options could be:
Switch to a repayment mortgage – Your lender should let you do this but if not you will need to remortgage over to a new lender. Changing from interest only to a repayment mortgage will dramatically increase the monthly repayments so you may also need to revise the mortgage term, if you can. This change will mean that your mortgage debt is being reduced with each payment.
Extend your mortgage term – Again, this will require your lenders approval. Adding extra years may allow you sufficient time to accrue the mortgage money, or maybe for your property to increase a bit more in value.
Overpay your mortgage – This is paying back more each month than your lender is expecting. For example, if your monthly interest only payments are usually £400, by paying £1000 pm you will be reducing the mortgage by £600 each month.
Mortgage Calculators
Get started with our free and easy to use mortgage calculators.
CONTACT A MORTGAGE BROKER
If you are ready to take the next step then we can put you in touch with a fully qualified independent mortgage broker.
What if I can’t pay it back?
If time is running out and none of the options above are possible then you probably need to seek some help.
Don’t leave this right to the last minute, or month, of your mortgage. It’s never too early to discuss how to solve this problem.
Contact your lender first so that they are fully aware of your situation and some of the options you have already tried. It is important to realise that as helpful as the lender will try to be, you will still need to repay all of the mortgage back to them.
If the issue is not addressed then eventually the lender will seek legal action to repossess the property and sell it so that the mortgage (and extra costs) can be repaid.
If there is no way of reducing the mortgage debt then you really only have two options:
- Sell the property and move somewhere else – This is effectively downsizing. The proceeds from the sale will be used to repay the mortgage. You may then be able to buy a cheaper property to live in or rent a property instead.
- Take out an equity release plan – Now an equity release plan is still a mortgage, but it is designed so that you do not have to make any monthly repayments or even reduce the mortgage. It is repaid only when you die. It’s not suitable for everyone but a later life mortgage could be a good option to consider instead of selling your home.
Try not to let this happen. There are charities that may be able to give guidance or you may choose to speak with an independent mortgage adviser.
