Your traditional mortgage, otherwise known as a repayment mortgage, requires that you repay the money you’ve borrowed in monthly installments. An interest-only mortgage, on the other hand, only requires that you pay the interest on your loan each month. You don’t have to actually pay back the loan in full until the end of the agreed term.
Lower monthly outgoings, but is it really worth it?
Due to the fact that, each month, you only need to pay the interest on your loan, an interest-only mortgage means less money will be leaving your account on a month-by-month basis.
This might sound appealing but, in practice, if you take a £200,000 interest-only mortgage on an agreed term of 20 years, you can pay off your interest each month and still be left owing the full £200,000 20 years later, money you will then need to be able to hand over in full to your provider.
With a traditional repayment mortgage, you will be paying larger monthly installments but each one of those payments will gradually pay back the lump sum you owe.
This means, with a £200,000 mortgage over 20 years, after 20 years of paying your monthly installments, you will own the property outright and you’ll owe nobody anything.
…and that’s why you should avoid interest-only mortgages
An interest-only mortgage means it’s possible for you to pay monthly installments for 20 years without shaving a single penny off the money you owe your provider. In such a case, when the agreed term ends, how are you going to afford to pay back the mortgage in one lump sum?
Unless you have managed to save £200,000 to hand over, you’re usually left with two options:
- Sell the property in order to raise the money you owe.
- Take another mortgage out on the property, thus starting the monthly payments all over again.
Neither of these are desirable outcomes, and that’s why you should avoid interest-only mortgages.
What if I’ve already got an interest-only mortgage?
If you have already taken out an interest-only mortgage, we strongly recommend you switch over to a repayment mortgage. Your monthly payments will go up, but each one of them will buy you a piece of your home and reduce the total amount owed.
If you’re concerned about being able to afford the larger monthly installments, make sure your new repayment mortgage can be repaid over a longer period of time (30 years instead of 20, for example), thus reducing the payment required each month.
If switching isn’t possible, you need to start saving money right away so that you can pay off the loan at the end of the term. It can be useful to appoint a financial advisor to help guide you through this process.
As well as putting money aside each month, it’s also a good idea to make overpayments on the interest, either on a regular monthly basis, or with periodical lump sums. This will enable you to pay back at least some of the money you owe your provider.
Have you had any experience with interest-only mortgages? Did it work out for you, or did you end up switching? Let us know in the comments section below.
And if you have any mortgage-related questions for our property expert, Russell Quirk, drop them in the comments below and he’ll get right back to you.