Interest Only Mortgages

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What is an interest only mortgage?
Interest only mortgages have encountered somewhat of a boom in popularity in recent years, and are often seen as a excellent way to get onto the housing ladder with a large number of first time buyers and buy to let investors alike choosing interest only mortgages over the more traditional capital and interest repayment mortgages.

Advantages of an interest only mortgage
Interest only mortgages are very simple, and as one might guess, you are simply paying the interest on your mortgage rather than repaying any capital, at the end of the mortgage term, you will still owe the initial mortgage amount.
One of the big advantages of Interest only mortgages is that it results in significantly lower monthly mortgages payments, and perhaps offers an ideal solution for first time buyers, as they can eventually move over to a repayment mortgage as their income increases. This can cause a major problem though, if it is not converted at a later date, as the mortgage balance does not reduce, and the lender will eventually want their money back.

When would an interest only mortgage be suitable
An interest only mortgage always carries an element of risk. Some people decide to take a "repayment vehicle" along side their interest only mortgage. Many people used to take out endowment policies, but nowadays people tend to link Pensions or ISAs to their interest only mortgage. This can provide tax efficiency in certain circumstances.
Other people chose to take a pure interest only mortgage, and convert to a repayment mortgage at a later date. This may be suitable for somebody who knows they will earn more in the future, ie a trainee account, or a junior teacher. If you are not expecting your salary to rise in the future in excess of normal inflation rises, then you should not be considering an interest only mortgage.
Some clients know they will be receiving an inheritance, or get regular lump sum bonuses which could be used to repay an interest only mortgage. You need to be aware that if this inheritance or bonus does not materialise, it could put your home at risk unless you found some other way of repaying the interest only mortgage.

The risks of an interest only mortgage
If you take an interest only mortgage, you are likely to pay more interest over the term of the mortgage compared to a Capital and Interest Repayment mortgage. This can have a considerable effect on the total amount payable, and you should discuss this with your financial advisor.
With an interest only mortgage, you are relying on a future event to pay your mortgage, whether this is a bonus, an inheritance, compensation, a gift, a pay rise. Nothing in life is guaranteed, and if this money does not become available to you in the future, you may be forced to sell your home to repay your mortgage.
In a market where house prices are falling, you are more likely to get into negative equity as the mortgage balance remains the same. This is more likely to be a concern if you put down a small or no deposit, as the equity in the house is already low. If you get into a negative equity situation (where your mortgage is higher than the value of your home), then you may find it difficult to sell the property as the lender will want the full mortgage repaid when the house is sold.
So what is suitable for me?

In most cases we would recommend a capital and interest repayment mortgage as the most suitable repayment type for your mortgage, however there are instances when an interest only mortgage would be more beneficial. At Mortgage Advice Network (UK) we can look at your current circumstances and future aspirations, and make a suitable recommendation for you.