Interest-Only Mortgages Concerns - Opportunity or Trap?

Interest-Only Mortgages Concerns – Opportunity or Trap?

There have been a number of major financial mis-selling scandals in recent years endowment mortgages, personal pensions and payment protection insurance are just three examples.

Some experts are becoming concerned that, before long, Interest-only mortgages could join that list.

So before committing yourself to this type of mortgage, it's essential to know all the facts.

Here's Your Quick Guide

How Do Interest-Only Mortgages Work?

What Else Do I Need To Know?

Do All Lenders Offer Interest-Only Mortgages?

Are Interest-Only Mortgages New?

Interest Only Mortgages - The New Endowment Mortgage?

Things to Consider

What's The Future For Interest-Only Mortgages?

Frequently Asked Questions

How Do Interest-Only Mortgages Work?

Interest-only mortgages work on a very simple principle: you borrow a sum (known as the capital) from your mortgage lender and each month you repay only the interest due on this debt.

Because you are not repaying any capital, as you would with a standard repayment mortgage (also know as a capital and interest mortgage), the monthly payments are considerably lower than they would otherwise be.

However, at the end of your mortgage term (typically 25 years, but it could be longer or shorter) you still owe the capital sum.

The idea behind this type of mortgage is that you have a separate savings or investment plan running alongside it, into which you also make monthly payments.

This repayment vehicle, as it's known, could be an endowment policy, an investment fund, another property or perhaps a pension fund.

There are pros and cons to all of these well, in the case of endowments and pensions only cons.

No matter what anyone tells you, no investment is guaranteed to provide the cash you need to clear your debt even another property could lose value if the market drops.

So, while an interest-only mortgage allows you to benefit from lower monthly payments, it will always be a risky choice.

If you can't pay off the capital sum at the end of the mortgage term, either because you haven't set up a suitable repayment vehicle or because it has underperformed, you will need to find another way to settle your debt or risk losing your home.

This is the gamble that you take with an interest-only mortgage.

What Else Do I Need To Know?

Although the lower repayments required by an interest-only mortgage can make getting on the property ladder more affordable in the short term, the long-term costs are generally far higher than for a repayment mortgage.

There are several reasons for this:

With a repayment mortgage you are gradually paying off the capital debt. This means that as time goes by, you owe less and so are charged less interest.

For example, someone with a £150,000 interest-only mortgage at 6 per cent interest would pay £750 a month giving a total bill of £225,000 over 25 years.

Of course, they would still owe the original £150,000 which means they would have to repay a grand total of £375,000.

However, someone taking the same mortgage on a repayment basis would pay £966.45 a month, made up of capital and interest.

By the time the 25 years were up, they would be debt-free at a total cost of just £289,935.

In other words, going interest-only would have cost an extra £85,065.

And because the interest bill is so much higher than for a repayment mortgage, interest rate rises have a bigger long-term impact on interest-only mortgage holders.

What's more, if your repayment vehicle doesn't perform as well as you hope, you could end up having to borrow from elsewhere to make up the difference or switch to a repayment basis quite late on in the term of your mortgage, increasing your overall costs.

To avoid being caught out by issues like these, it's vital that you fully understand the mortgage you're taking and have a sensible repayment plan in place right from the start.

If in doubt, talk to an independent financial adviser and make sure they explain all the options to you.

If there's anything you don't understand, never be afraid to ask when it comes to mortgages and investments, there's no such thing as a stupid question.

And if your adviser makes you feel there is, ditch them and go to one who doesn't talk down to you.

Remember: you're doing them a favour by offering them your business.