While interest-only mortgages may sound like a more attractive option because of the flexibility, it’s important to note that it’s not always the most sensible option or you to go towards.
With a repayment mortgage, the borrower is required to reduce the equity each month, and it isn’t optional; so, the borrower will eventually clear the debt, or at least reduce the debt. By reducing debt, equity is gained- that’s the key point of this type of mortgage. If you are unsure whether an interest-only mortgage is best for your situation then you can contact an independent mortgage advisor who will be able to provide you with the advice you need.
Reducing the capital with an interest-only mortgage is more of an option, so it’s not always done. In fact, most borrowers rarely make overpayments because they’d rather pay less, so they have extra money for the luxuries of life. While that sounds like an attractive option, it can be hazardous if house prices drop off.
Imagine if you bought a house for £200k on a 100% mortgage and make no overpayments. Then out of nowhere, the property market takes a turn for the worst and house prices drop by 5%. You’re suddenly left with a property worth £190k, but paying off a mortgage of £200k. This is what is known as ‘negative equity’.
With a repayment mortgage, you’re unlikely to be hit by negative equity in the long run if the market takes a negative turn because each month you increase equity when reducing the debt.
Interest Only Mortgages
Interest-only mortgages have the advantage of lower monthly repayments, but that’s because your repayments only cover the interest being charged on the amount of money that you borrow. The actual mortgage balance doesn’t reduce over the mortgage term. But it is repaid in full at the end or by lump sum reductions throughout the term, and this is usually through the means of a repayment vehicle such as an endowment policy or other investment plan.
Prior to lending money on an interest-only basis, your mortgage lender will want to see that you have an established repayment plan in place. Acceptable repayment plans can vary from lender to lender but may include ISAs and stock market investments. Your mortgage lender is likely to make periodical checks that your chosen repayment plan is on track to pay the required amount.
Previously, mortgage lenders would allow borrowers to rely on the likelihood of a future windfall such as inheritance money or a workplace bonus, but only a very select amount will accept these now.
If you’re concerned about repaying the amount that you owe on an interest-only mortgage, then you should take action now, even if you’re numerous years away from the mortgage end date. The longer that you leave it, the fewer options you will have so it’s important to seek financial guidance as soon as you possibly can.
A repayment mortgage has a higher monthly payment amount than an equivalent interest-only mortgage. This is because each month a portion of the debt is being paid off, so by the end of the mortgage term, the balance will have been reduced to zero. Because the mortgage capital is always reducing, this also means that you will pay less total interest over the overall mortgage term compared to an interest-only mortgage.
Mortgage interest rates vary with the market conditions. At any time, there might be hundreds of different mortgage products on the market and can also depend on various factors such as the amount of deposit you’re able to put down on a mortgage, and your credit rating.
Several different types of repayment mortgages are available in the United Kingdom, including:
Fixed-rate mortgages. The interest rate remains fixed for a set period.
Guarantor mortgages. A family member guarantees the loan, meaning a lower interest rate or a bigger mortgage.
Tracker mortgages. Your interest rate tracks the base rate plus a set percentage.
Discount mortgages. Your interest rate tracks your lender’s standard variable rate minus a set-out percentage.
SVR mortgages. The interest rate is the same as your lender’s standard variable rate.
Offset mortgages. The interest rate is based on the amount of money that you have borrowed minus savings held in the linked account.
Repayment mortgages are the most popular type of mortgage in the United Kingdom. It is worth remembering that when budgeting your payments on a repayment mortgage that the term taken at the outset can be adjusted in the future if you wish.
Many homeowners are now taking repayments mortgages over 30 or even 40 years to keep their monthly repayments low in the first few years. A repayment mortgage term can be changed merely by contacting your mortgage provider in the future when you feel you can afford to increase your monthly repayments. It is noteworthy to remember that your mortgage lender may charge a small fee to change the term of your repayment mortgage.