Interest Only Mortgages UK
Interest only mortgages are different to standard repayment mortgages. An interest only mortgage means that you only pay the interest on the mortgage loan and do not pay any capital back. It means at the end of the mortgage term (in 25 or 30 years) you will still owe the full amount of your mortgage.
Interest only mortgages are becoming increasingly popular with first time buyers because of the increased cost of UK house prices. Interest only mortgages are often the only way that first time buyers can afford to pay for a mortgage, at least in the first few years.
Some interest only mortgages may have an option to switch to repayment mortgage after a number of years. Check to see how much the mortgage dealer will charge for switching. This is important as it makes a good idea to switch from interest only, if your financial situation improves.
Benefits of Interest only Mortgages.
- You will end up paying more interest payments over the course of your mortgage term. With a standard repayment mortgage the value of your debt diminishes therefore the interest payments decline as the debt diminishes. At the end of your mortgage term, the interest on the debt will be quite small. With an interest only mortgage all your outgoings do nothing to reduce your debt.
- Negative equity is more likely. When house prices fall homeowners might be more likely to experience negative equity. With a standard repayment mortgage the value of your debt diminishes making negative equity less likely.
- Alternative investment schemes can be more risky. In the 1980s many took out endowment mortgages, these are similar in principle to an interest only mortgage. However the investments proved to be generally unsuccessful and so many mortgage owners were left with significant shortfalls. Relying on an alternative investment plan can leave you exposed at the end of the mortgage term because you may not be able to pay back the mortgage loan. It may mean you have to take out another mortgage into your retirement.
- Interest only mortgages are more sensitive to changes in the base rate. Taking interest only mortgages means that any change in the base rate will have a correspondingly bigger impact on your disposable income. This has proved to be a problem recently in America with interest only mortgages proving a major factor in record defaults on sub prime mortgages.
Advantages of Interest only mortgages
- If the alternative to interest only mortgage is renting then paying an interest only mortgage is more attractive. It enables you to own a house with the option of paying off capital later in the mortgage term.
- The real value of interest payments decreases as inflation erodes the real cost of mortgage interest payments. For example if your interest payments were £800 a month, that may sound a lot but if real wages were to increase by 4% each year, then in 10 years time £800 will be a much smaller % of your income. Therefore in the future it will be easier to pay off.
- You can switch to a standard repayment mortgage when your financial situation improves.
- You may be able to find a better investment deal which enables you to raise sufficient funds to pay off the mortgage debt.
A lot depends on the future of house prices and the future of interest rates. It is possible to combine an interest only mortgage with a fixed rate of interest rate. This can be important for those who are on the margin of being able to afford mortgage payments. If house prices rise then it is easier to remortgage in the future. If house prices were to fall in the UK (which is a good possibility in the future) interest only mortgages are more likely to cause negative equity.
In general interest only mortgages are not an ideal mortgage because they tend to work out in the long term. However they shouldn’t be discounted just because of this. Mortgage lenders are giving more interest only mortgages because they realise it is a practical alternative for first time buyers struggling to meet payments.
I would always suggest an interest only mortgage is more attractive than renting and not getting on the property ladder.
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