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How will I pay off my interest only mortgage?

06th November 2018

There are three mortgage options when you buy a property: a repayment mortgage, an interest-only mortgage and part repayment or part interest-only. With a repayment mortgage, you pay back a part of the loan and the interest each month. Assuming you make all your payments, you are guaranteed to pay off the whole loan at the end of the term. With an interest-only mortgage, each month, you only pay the interest on the loan. Therefore, at the end of the term you owe the original amount you borrowed minus any interest.

Interest only lending was popular ahead of the 2008 financial crisis. Customers were able to borrow on an interest-only basis without showing lenders exactly how the debt would be repaid. After the credit crunch struck, it became apparent that some interest only customers may struggle to pay off their home loan at the end of their term. In this post, we provide advice on how you can plan to pay off your interest only mortgage.

 

What is an interest only mortgage?

With an interest-only mortgage, your monthly payment is the interest charged on your loan but not any of the original capital borrowed. You do not have to repay the amount borrowed until the end of the mortgage term. This means your monthly payments are less than on a repayment mortgage. However, at the end of the term, you will still owe the original amount you borrowed from the lender (and you do not own the property outright until your mortgage is paid off).

Understandably, before lending money via this mortgage option, your lender will want to see that you have an approved repayment plan in place. Your options for this may include any ISAs or stock market investments you have, sale of any other properties you own, lump sum payments from a pension scheme that matures or downsizing or selling property you own and moving to a less expensive property. Acceptable repayment plans vary from lender to lender, so it is good to seek advice before you commit to one. Your lender will make periodic checks to see if your chosen repayment plan is on track to pay the required amount.

 

Interest only mortgage: pros and cons

Pros of interest only Cons of interest only
  • Short-term affordability: lower monthly payments
  • They can work out more expensive overall and in the long-term: every month you pay the same amount of interest on the same balance (with a repayment mortgage the total balance is decreasing – as is the interest as a % of this)
  • Flexibility: you can choose where your money goes, for example, you can decide how you will save to pay back the mortgage balance or use surplus towards home improvements
  • Your mortgage and the repayment vehicle are separate therefore you need to be vigilant about monthly payments and your repayment vehicle
  • Potential profit: if your investments perform well, you could save up enough to pay off your mortgage more quickly (or keep a lump sum)
  • More risky: if your repayment vehicle performs badly you may be unable to pay off your mortgage and will not own your property

Why interest only mortgages can be a good option

Affordability is a key when opting for interest only mortgages. For example, if you own multiple cars, holidays, are a parent, pay school fees or are responsible for covering any other expenses on top of your mortgage – the ability to postpone a large sum of your mortgage payments until later in life is useful. The main advantage with an interest only mortgage is that your monthly payments are cheaper. This is particularly appealing when you are at an especially expensive time of your life, for example around the time that you and those close to you are settling down. With yourself and friends getting married, buying pets, having children, going travelling, paying for school fees, family holidays, purchasing golf membership – monthly outgoings can increase a lot as you get older.

However, as you approach retirement, some of these costs may have reduced or disappeared (such as school fees). This can place you in a good position to pay off your interest only mortgage. What is more if you have strategically invested the money not paid towards the total balance of the mortgage each month, you may have made a profit on this which can also help you to pay off your mortgage.

Be aware

Not all lenders offer interest only mortgages and those that do often have strict criteria such as a large deposit and an approved repayment vehicle in place to pay off the capital at the end of the term. There is one exception: buy-to-let. Many landlords pay their mortgages on an interest-only basis and lenders generally accept this. In any case, if you are not able to repay the amount you borrow at the end of the term you will need to take out a new mortgage or sell the property in order to pay off your original mortgage.

It is unlikely that you would not be able to pay off your mortgage at the current time – hence your decision to apply for an interest only mortgage! Therefore, before committing to one, you need to make plans as to how you will be able to afford the final payment at the end of the term.

 

Repayment planning: how to pay off an interest only mortgage

If you have made the decision to opt for an interest only mortgage, the next question is: how are you going to pay it back? Of course, we cannot plan financially for every possible unforeseen event but it is important to know you should be able to repay the capital when the time comes. For starters, often the end of mortgage terms coincide with when people are thinking about stopping work. There are various options that we discuss with people as potential ways for them to ensure that this happens:

  • Move home – selling off your current property and buying at a lower value (and possibly mortgage free) could provide you with a profit to pay off your original mortgage.
  • Switch your mortgage to a repayment mortgage – your monthly payment will increase but your mortgage will be repaid in full at the end of the term.
  • Speak to a financial advisor about paying into investment plans – these could be used to pay off the capital at the end of the term.
  • Pension pot – you may have money in a pension pot that will mature when you need to pay off your mortgage.
  • Inheritance – we do not recommend relying on this, however it is common that people will receive inheritance money or investments later on in life.
  • Annual bonuses – perhaps you receive annual bonuses which are forecast to increase in the coming years and could cover some of your mortgage repayment.
  • Set up an affordable regular overpayments on your mortgage – this will reduce the amount owed in the end of term payout.

If are concerned about repaying the amount owed on an interest-only mortgage, take action now. Even if several years away from the mortgage end date, the longer you leave it, the fewer options you will have. This is why it is important to seek financial advice as soon as possible.

 

Seek out independent mortgage advice to ensure that you choose the right mortgage for you and your lifestyle. Acting primarily as insurance and mortgage financial advisors, IMC has been successfully operating in the financial sector since 1996.

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