Interest only mortgages for residential property all but disappeared after the 2007-08 Financial Crash, but now they’re making a come-back. Residential Consultant Broker, Chris Unwin, explains what they are and when they can be a suitable mortgage option...
What is an interest only mortgage?
Many residential mortgages require “capital and interest” repayments; each month you pay off a bit of the capital (the amount you borrowed) and also pay the interest that’s been charged. However, with interest only mortgages, your monthly repayments do not pay off any of the capital, you’re simply paying the interest on the loan. At the end of the mortgage term, you still owe the full capital amount.
In order to pay back the capital loan at the end of the mortgage term, you will need some form of an investment scheme, often referred to as a ‘repayment vehicle’.
Repayments vehicles usually accepted by lenders include (but are not limited to):
- Financial endowments
- Equity in other property
Upon application, the lender will check that your proposed repayment plan should raise enough money to pay off the capital loan at the end of the mortgage term and will likely make periodic checks throughout the term to ensure it’s still on track.
There are very few lenders who will accept the possibility of future “windfalls”, such as inheritance or bonus’, as a reliable repayment vehicle option. Pre the 2007-08 Financial Crisis, the majority of lenders would have accepted that as an option, as many didn’t require you to evidence what your repayment vehicle was going to be at all. The consequence of this was that thousands of interest only mortgage holders were left unable to repay their capital loans at the end of their term. The Financial Conduct Authority (FCA) estimates there are some 1.5million outstanding interest only residential mortgages in the UK, mostly caused by under-performing investment schemes or simply because the client never set one up in the first place.
Post the 2007-08 crash, residential mortgages became heavily regulated by the FCA and, until very recently, it’s been almost impossible to get an interest only mortgage for your residential property (although they’re common for buy to let mortgages).
When are interest only residential mortgages suitable?
If you already have a repayment vehicle, such as an ISA or second property with sufficient equity to pay off the mortgage, then an interest only mortgage may be suitable for you. Your broker will be able to advise you on whether your repayment vehicle will satisfy a mortgage lender and help you find appropriate finance.
Benefits of an interest only mortgage
The main benefit, and why they were previously so popular, is that your monthly repayments are much lower than you’d get with a regular capital and interest repayment mortgage. This gives you greater flexibility with your monthly cash flow and more funds available for investment.
The other benefit is that if your repayment vehicle performs well, there is a chance you will make a profit, even after you’ve paid off the capital loan.
Drawbacks of an interest only mortgage
Having an interest only mortgage requires you to be very diligent with how much you invest each month for your repayment vehicle to succeed. If a sufficient amount is not invested safely and regularly, you expose yourself to the risk of having a shortfall at the end of the mortgage term.
As with any investment scheme, there is always the chance it won’t perform as well as expected, which again exposes you to the risk of financial shortfall. Possible consequences of this are that you will be forced down other financial routes, such as extending your mortgage term, or worse, your home will be repossessed.
While monthly repayments are less than those of capital and interest mortgages, they can end up being a more expensive option over the course of the mortgage term. Rather than being charged interest on a decreasing amount of capital, as you are with a traditional residential mortgage, you will always be paying interest on the full capital amount for the duration of the mortgage.
I have a shortfall on my current interest only mortgage – what do I do?
Speak to a mortgage adviser as soon as possible. The sooner you address the issue, the more likely you are to be able to manage the financial implications.
If you’d like to know more about interest only mortgage for residential property and discuss the options that may be available to you, please do not hesitate to contact me, Chris Unwin on 01625 416 394 or email chrisU@mortgagesforbusiness.co.uk.
31st January 2020