Interest only mortgages.
Interest only mortgages
Got a separate plan to pay off your mortgage balance? An interest only mortgage could be right for you.
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With an interest only mortgage your monthly repayments will only cover the interest element of the loan, not contributing to reducing the overall mortgage balance. You will still owe the same amount at the end of the mortgage as you did at the start (plus any added fees or additional interest, and as long as all monthly interest payments have been made in full and on time). This means you will need a separate method of clearing the capital – known as your repayment strategy.
The main alternative is called capital & interest, where monthly repayments cover the interest due plus a portion of the capital borrowed. Gradually you’ll own more of your home and at the end of the mortgage term your mortgage will be repaid in its entirety (subject to all payments being made in full and on time).
Another option which may be available is part interest only and part capital & interest, often shortened to part and part, which combines both repayment methods to suit the borrower in varying ratios.
If you have an alternative method to repay the full mortgage amount, an interest only mortgage offers lower monthly repayments than a capital & interest mortgage, as you’re not contributing towards clearing the funds borrowed.
However, you should consider that an interest only loan will cost more in interest payments over the life of a loan, because the balance does not reduce over the term, and therefore you will pay monthly interest on the entire balance for the full term of the mortgage. (With a capital & interest mortgage the balance gradually reduces with each monthly payment, therefore the amount of interest paid each month will also reduce.)
When you take out an interest only mortgage your lender will require you to demonstrate you have an adequate repayment strategy in place. This could be, for example, through a pension lump sum or a second property.
If you are concerned you may not have a suitable repayment strategy in place you will need to get in contact with your lender as soon as possible. This will enable you to work together to make suitable alternative arrangements.
Everyone has a personal level of risk tolerance, but it is generally acknowledged that an interest only mortgage is riskier than a capital and interest repayment loan – because you need to ensure you are able to pay off the loan in full at the end of the mortgage term.
Mortgage lenders are obligated to make sure borrowers have a suitable repayment strategy in place at the outset, so applicants who don’t have a repayment plan or know how they’d repay the loan simply couldn’t borrow the funds in the first place.
Eligibility for an interest only mortgage loan typically comes down to three main factors:
- Whether you have a suitable repayment plan in place to repay the mortgage capital at the end of the term.
- If your loan to value (LTV) is below a certain ratio – you won’t be able to get an interest only mortgage if you’ve got a typical first time buyer deposit of 5% or 10%. Usually you’ll need at least 30% to put forward before you can access interest only mortgage deals.
- You’ll need to pass the affordability assessment and credit checks carried out by your lender, so be prepared to submit details of your income, financial commitments and your outgoings.
Typically interest only mortgages will be available for both purchases and remortgages, so you’ll just need to check the product information carefully. To view the interest only remortgage deals we have available use our mortgage finder.
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