There are two basic parts to any loan. One part is the sum borrowed, sometimes known as the capital. The other part is the fee charged by the lender. In terms of mortgages, this fee is usually charged in the form of interest.
At this time there are three basic types of mortgage available:
Repayment mortgages – in which the monthly repayments are set at a level which ultimately repays both the capital and the interest.
Interest-only mortgages – in which the monthly repayments only pay the interest and the borrower must make other arrangements to pay off the capital at the end of the loan period.
Offset mortgages – in which the mortgage is roughly equivalent to a huge, fixed-term overdraft.
The History of Interest-Only Mortgages and The Endowments Scandal
The endowment mis-selling scandal of the 1980s still has the power to generate strong emotions. In short buyers bought property on interest-only mortgages. They also purchased endowment policies to go along with them. The idea was that the endowment policy would not only pay off the mortgage capital but also make the home-buyer a profit. Unfortunately in many cases the endowments didn’t even pay off the mortgage capital. This meant that some home-buyers found themselves scrambling to find an alternative way to pay off the balance of their mortgage. The resulting scandal highlighted the fact that home buyers often did not understand the product they were being sold.
Interest-Only Mortgages and Buy to Let
Notwithstanding this, interest-only mortgages remained a staple of the buy-to-let market. The key difference here being, of course, that the legal home owner does not live in the property. Interest-only mortgages increasingly became a means of building personal wealth by investing in property rather than for buying a home to live in.
Interest-Only Mortgages Return to The Residential Market.
Now interest-only mortgages are starting to make a comeback into the residential housing market. Leeds Building Society, for example, is currently offering an interest-only mortgage with a choice of 3 introductory deals. There are stringent conditions attached, such as a minimum 50% deposit. Interestingly this mortgage allows for 10% of the capital to be repaid each year without early repayment penalties being applied. This means that technically it could be used in a similar way to a repayment mortgage, but with more flexibility with regards to how much is paid each month. Meanwhile the Clydesdale Bank is offering interest-only residential mortgages to high-net worth customers with a minimum 25% deposit.
The Reality of Interest-Only Mortgages
Like all financial products, interest-only mortgages need to be examined in the context of an individual’s financial situation. There are three key points to bear in mind when considering them.
Firstly the affordability criteria introduced in 2014 applies to interest-only mortgages in the residential market. You will therefore need to be able to provide evidence that you can afford the monthly repayments as well as having a feasible plan to repay the capital. When considering this point, think about what would happen if you couldn’t sell your house at the end of the mortgage period. Say there was a lull in the market or a temporary drop in house prices. How would you cope in that situation?
Secondly deposits matter to interest-only mortgages in the same way as they do for other kinds of mortgages. It is therefore important to have savings in place to be able to make a respectable down payment.
Thirdly, and possibly most importantly of all, it is absolutely vital to have a plan in place to pay back the capital. It is also crucial to “stress test this”. This includes making contingency plans for unexpected life events. For example what will happen if you are unable to work for a time, perhaps because of illness? It also includes thinking about unexpected financial situations. For example, if your plan is to pay off the capital with income from investing, what will happen if your investments under-perform?
Getting some advice from a financial adviser can help to resolve these issues and give you the best chance of finding the right mortgage for you.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE