What is an interest only mortgage?
With a standard mortgage, your monthly payments partly go towards repaying the money you borrowed (known as the capital debt), and the rest covers the interest on the remaining loan. Over time, the capital debt reduces, and after your final repayment is made, your mortgage will be settled, with no more money owed.
With an interest only mortgage, you are only required to pay off the interest on the capital debt each month, without paying off any of the actual capital debt itself.
This means that without taking further steps to clear your capital debt, you will still owe the same amount to the lender at the start of the mortgage as you did at the end.
How do you settle the capital debt on an interest only mortgage?
Some people are comfortable with using an ISA, investment fund or pension withdrawal to clear the capital debt. And other people look to a potential lump sum, such as an inheritance, to clear the outstanding balance. It’s also possible to sell the property at some point to pay back the money owed to the lender.
However, this approach requires being comfortable with a certain amount of risk. You are relying on investments to perform well, and inheritances to come through as planned. And of course, selling the house to cover the outstanding capital debt relies on house prices rising, and your property selling without problems. None of these things can be guaranteed.
For many people, relying on these kinds of unknowns to secure the roof above their heads is not a risk they are comfortable taking.
Who might benefit from an interest only mortgage?
Most buy-to-let mortgages are interest only. This kind of arrangement generally suits someone looking to become a landlord, who is comfortable looking at their mortgage as a business loan. It gives them greater leeway to balance paying off the debt, with investing the rental profits in repairs and upkeep. And because a buy-to-let property isn’t a landlord’s primary residence, they can always clear the capital debt by selling the house if they need to, without losing their home.
Meanwhile, for people who are stretched by expensive rental costs, and eager to get on the property ladder, it can be a worthwhile option in the short term. However, this should be done with an eye to moving over to a repayment mortgage as soon as possible.
If you are currently on an interest only mortgage, thinking of getting one, or want to see what other options are available to you, get in touch with us today. Our advisors can help you figure out your next step.