If you find yourself in a situation where your monthly mortgage payments are becoming unmanageable, there is an option to consider: going interest-only. Interest-only mortgages, which gained popularity before the 2008 financial crisis, allow borrowers to repay only the interest on the loan, effectively cutting their mortgage payments in half.
Back in the days leading up to the financial crisis, borrowers were taking on massive interest-only mortgages without any real plan to repay the principal amount. However, the stricter affordability tests implemented after the crash changed the game for them. Despite this, interest-only mortgages have made a comeback in recent years, although lenders are now much more selective about who they offer them to.
In terms of repayment, interest-only mortgages can provide much-needed relief for borrowers who meet certain criteria. For example, someone with a £200,000 repayment mortgage over a 20-year term at an interest rate of 5.5% would be paying around £1,376 per month. By switching to an interest-only deal, their monthly payments would decrease to a more manageable £917. Similarly, a borrower with a 15-year £400,000 mortgage could see their payments nearly halve from £3,268 to £1,833 on an interest-only deal.
David Hollingworth, an associate director at the broker firm L&C Mortgages, explains that going interest-only can work, but it’s crucial to be the right kind of borrower. This means having a solid history of financial repayments, a substantial amount of equity in your home, and a desire for some breathing room. However, one must remember that with interest-only mortgages, the debt itself is not being repaid. So while it may not be an issue for younger individuals, older borrowers could face challenges due to not repaying the principal amount when the mortgage term ends.
Lenders now require evidence of a repayment plan and usually only offer interest-only options to borrowers with significant equity in their homes. For instance, Barclays sets a minimum equity requirement of £300,000 for interest-only deals. Other lenders also want to see that the borrower owns a significant portion of their home, which can rule out many potential borrowers.
While numerous interest-only deals are available, a closer look reveals that they often require substantial equity. For individuals looking to borrow £400,000 against their £600,000 home, there are many providers to choose from, with the Cumberland Building Society offering the lowest rate at 4.59%. However, attempting to borrow £500,000 against the same property eliminates all those offers.
So, who is best suited for an interest-only mortgage? Ideally, it would be someone with a proven repayment history over several years and a considerable amount of equity in their home. Typically, these borrowers tend to be higher earners or individuals who purchased their homes a while ago. While owning at least 25% of your home is often a prerequisite, eligibility ultimately depends on individual circumstances.
Hollingworth suggests that going interest-only for a shorter period is preferable to extending the repayment mortgage term to 30 years or longer, as long as you have a plan to make up for the shortfall in repayments.
In terms of interest rates, borrowers taking out an interest-only deal can expect similar terms to those opting for repayment mortgages, typically ranging from 4.5% to 6%.
Another option to consider is a part-interest-only deal, where lenders allow borrowers to have 75% of their mortgage on interest-only terms and the remaining 25% on repayment terms. This flexibility could be the key difference in qualifying for an interest-only deal.
Lastly, don’t overlook your existing lender, as they may be willing to assist borrowers struggling with mortgage payments by offering a temporary switch to interest-only.
Ultimately, going interest-only can be a viable solution for households seeking relief from unaffordable mortgage payments, but it is essential to meet the criteria and have a well-thought-out plan for repayment.
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