Interest only mortgages
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Interest only mortgages
When it comes to picking a mortgage, there are a few different options to choose from, but few get people talking as much as interest only mortgages. These are a specialist type of mortgage and, though they are slightly less common than standard repayment mortgages, they are still extremely useful. Interest only mortgages tend to have stricter lending criteria than traditional mortgages, and there’s a greater responsibility for the borrower to keep on top of things, but they do work well for the right buyers, in the right circumstances.
At Everest Mortgages, we know interest only mortgages can appear complex at first, but we’re here to help you navigate the process. With our mortgage broker knowledge, we help you to understand whether an interest only mortgage works with your goals, finances and long-term property plans.
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What is an interest only mortgage?
With a standard mortgage, your payments go towards the money you have borrowed, as well as the interest that the lender is charging on that borrowing. At the end of the mortgage term, everything will be paid off. But, with an interest only mortgage, your monthly payments only cover the interest side of things. The amount you originally borrowed – which is known as the capital – doesn’t reduce over time. This means it must be repaid in full at the end of the mortgage term.
As you’re not paying off the capital each month, interest only mortgage repayments are usually a lot lower than with a standard mortgage. However, the responsibility for repaying the mortgage at the end of the term is down to you.
Who are interest only mortgages suitable for?
Interest only mortgages aren’t suitable for everyone, which is why lenders are careful about who they approve. They’re most commonly used for buy-to-let landlords, property investors and buyers with high incomes and substantial assets, who won’t struggle to pay off the remaining loan at the end of the mortgage term. These mortgages aren’t usually used by residential buyers, simply because lenders will typically expect a larger deposit than is needed for a repayment mortgage, a strong repayment plan – such as investments, savings or other property assets – and an impressive income, which not many residential buyers have.
How interest only mortgage capital is repaid
When you’re applying for an interest only mortgage, you need to be able to show how you plan to repay the full loan amount at the end of the term. If you can’t, lenders won’t approve you. There are a few different repayment strategies available, such as stocks and shares ISAs, the sale of the mortgaged property, the sale of other properties, investment portfolios and savings.
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The advantages of interest only mortgages
There are a few key benefits of choosing an interest only mortgage, including:
- The monthly repayments are lower, which can help with cash flow.
- They’re popular with landlords, as rental income can be used to build capital elsewhere.
- You get increased flexibility during renovations or improvements, which is helpful for investment properties.
- They’re useful during void periods between tenants, when income may be reduced.
Of course, there are also a few downsides of interest only mortgages, which is why they’re not suitable for everyone and careful planning is a must.
- You have to repay the full loan amount at the end of the term, which is likely to be a hefty amount.
- Lenders require proof of a reliable repayment strategy, and you won’t be approved without one.
- The mortgage balance doesn’t reduce over time, only the interest.
- Property prices can fluctuate, which could affect your plans if you’re relying on a future sale to repay the loan.
What happens at the end of an interest only mortgage?
As your mortgage term approaches its end, your lender will contact you, which usually happens around 12 months beforehand. If your repayment plan is on track, the capital is repaid as agreed. If your circumstances have changed, you’ll have to explore other options, such as refinancing, selling the property or switching to a repayment mortgage.
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3 types of interest only mortgages available
Interest only mortgages can be arranged with different interest rate structures, similar to repayment mortgages. Common options include fixed rate mortgages, tracker rate mortgages and variable rate mortgages. These work in slightly different ways, but can all fall under the interest rate mortgage umbrella.
- With a fixed rate mortgage, your interest rate stays the same for a set period, which is usually 2 to 5 years.
- But, with a tracker rate mortgage, the rate moves in line with the Bank of England base rate.
- A variable rate mortgage is slightly different once again, as the lender can change the rate at their discretion.
As your payments only cover the interest part of the loan, the rate you choose has a direct impact on affordability. This is why it’s important to get professional advice, which is where Everest Mortgages come in.
Could an interest only mortgage be right for you?
Interest only mortgages require careful consideration, detailed planning and access to the right lenders, all of which we can help you with. As an experienced mortgage broker, we provide clear, honest advice and guide you towards the ideal interest only mortgage for your property purchase.
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FAQs
Frequently asked questions
Can first time buyers get an interest only mortgage?
It’s possible, but it’s not common.
Most lenders prefer first time buyers to take out a standard repayment mortgage, as many first time buyers struggle to meet the eligibility criteria for interest only lending. If you do apply for an interest only mortgage as a first time buyer, you will need a high income, a large deposit and a strong repayment strategy.
Do interest only mortgages cost more overall?
Yes, they can. As you’re not paying off the capital during the mortgage term, interest is charged on the full loan amount for the entire duration of the mortgage. This can mean the total amount paid can be higher than with a repayment mortgage.
Are interest only mortgages only for buy-to-let properties?
No, but they are commonly used for buy-to-let and investment properties. Residential interest only mortgages are available, but approval criteria is stricter and usually reserved for borrowers with strong finances and a clear repayment plan.