Everything you need to know about interest-only mortgages
Posted 17 October 2016 by Nick Parkhouse
According to research from Citizens Advice, there are around 3.3million people in the UK with an interest-only mortgage.
These mortgages were particularly popular in the early to mid 2000s. They enable borrowers to make a monthly payment based on the loan interest, while the balance of the mortgage never reduces. The intention is for borrowers to build up a lump sum in order that they can pay off the mortgage at the end of the term.
However, research has found that thousands of borrowers may not be able to repay their interest-only mortgage when the term ends. A new study has found that over a quarter of interest-only mortgage holders may not be able to pay back their home loan - equivalent to around 890,000 borrowers.
Our guide tells you everything you need to know about interest-only mortgages.
Interest-only mortgages - the ticking time-bomb
New research from financial mutual OneFamily has revealed that over a quarter (27%) of interest-only mortgage holders may not be able to pay back their loan at the end of the agreed time period. The study found that the expected unsettled debt stands at an average of £21,000.
One in ten respondents said that they have no plan in place to repay their mortgage. 2015 Citizens Advice research found that 430,000 people “have not even thought about how they will repay the capital” to their home loan.
Simon Markey, CEO of OneFamily says: "Our research adds to a disturbing picture facing thousands of homeowners who do not yet know how they are going to meet their mortgage obligations. With many just not sure what to do, it's vital they seek advice on all the options."
What you can do if you have an interest-only mortgage
If you have an interest-only mortgage and you are worried that you won't be able to repay the debt when your mortgage term ends, there are steps that you can take. These include:
The OneFamily research found that 24% of mortgage holders plan to downsize in order to pay off their debt. This will involve selling their home and moving somewhere less expensive in order to free up funds to use to repay the mortgage balance.
While this is the chosen option for many, it does depend hugely on prevailing house prices at the time you sell. With years to go on your mortgage, there is no guarantee that the value of your property will continue to rise.
2. Make overpayments
24% of borrowers questioned by OneFamily said that they were planning to make overpayments to their mortgage in order to clear the debt.
There are two ways that you can make overpayments:
On a monthly basis if you have a flexible mortgage where the interest is calculated daily
On a 'lump-sum' basis once you have saved up your lender's minimum capital repayment (typically £500 or £1,000)
Most fixed- and discounted-rate mortgages allow you to make overpayments without penalty - typically up to 10% a year.
3. Cash in investments
One in five people questioned by OneFamily said that they were planning to use investments to clear their mortgage debt. This might include:
- Endowment policies
- A lump sum from a pension
4. Take out an equity release or lifetime mortgage
In recent months, many lenders have come to the market with 'equity release' or 'lifetime mortgage' products.
These products allow you to remortgage your home in order to pay off your mortgage lender. Your home still belongs to you and you’re responsible for maintaining it. Interest is charged on what you have borrowed and this interest is generally added on to the total loan amount.
When you die or move into long-term care, the home is sold and the money from the sale is used to pay off the loan. Anything left goes to your beneficiaries.
"For homeowners in or approaching retirement, lifetime mortgages offer a real alternative," adds Markey.
"They give families more choice and greater flexibility in how they manage their finances. They are also a great solution for people facing a repayment shortfall at the end of their interest-only mortgage and a means of unlocking capital while staying in the family home."
Bear in mind that the total amount you owe can grow quickly if you choose to 'roll up' the interest. Eventually this might mean that you owe more than the value of your home, unless your mortgage has a 'no-negative-equity guarantee'. It may also affect the amount you leave as an inheritance.