Interest Only Mortgage - A Quick Guide

Figures published this year by the Council of Mortgage Lenders show that of the first-time buyers getting onto the property ladder this year, some 29% did so using an interest-only mortgage. With the increase in house prices it is no wonder that first-timers will do whatever they can in order to keep costs down. However, the problem lies when the time comes to repay the actual capital of the loan. Without a plan of action to keep on top, there may lie some serious problems ahead.

So what are the potential risks of staying interest-only? An interest-only mortgage is just that: you repay only the interest of the loan while the actual debt remains the same. At the end of the term if no repayment plan is in place the options are to either take out a further mortgage, to which there is no guarantee you will qualify, or finding yourself having to sell your home in order to repay the lender. Naturally throughout this time house prices will have risen, so if you are in a position where you have to sell your home, you also run the risk that you will have insufficient capital to buy another one. The short of it is: you could lose your home and in addition owe money as well.

With all this in mind, it would appear that the majority of first-time buyers are clearly not put off by such risk, in a bid the finally get on that property ladder. The CML claims that the number of first-timers opting for an interest-only mortgage is ever increasing rising from some 5,000 buyers in June 2004 to over 10,000 today. However, it is important to state that some 80-90% of first-time buyers have cautiously opted for a fixed rate mortgage which allows a greater level of security in terms of providing a barrier against a rise in the interest rate.

Not surprisingly, with an average UK property price standing at £185,500, according to figures given this July by a leading Building Society and with available mortgages at up to five times a single average income, first-time buyers are almost forced into an interest-only mortgage out of desperation as the only affordable way to purchase a home. Additionally, figures given by CML show that the average amount borrowed by a first-time buyer this year was around £120,000. The average income remains at a steady £22,500 proving that any capital borrowed will be a sizable amount indeed.

The Financial Services Authority (FSA) has since raised concern regarding repayment of interest-only loans when it was discovered that a percentage of borrowers were unsure as to how they would make payment on the outstanding capital of their mortgage.

Providing a repayment plan is in place for long term security, a short term interest only mortgage may not be a bad thing for the first few years. Instead of being tight for any spare cash due to the size of the repayments, a little free money is available to help with moving costs or initial household repairs and alterations etc.

Moving over to a repayment mortgage once the interest-only term is up, may not be quite so bad as first thought. The difference between an interest-only and repayment mortgage is not a severe as it used to be due to interests rates remaining relatively low. For example, a £100,000 interest-only mortgage over 25 years priced at 7% would cost £583.84 a month, against £706.77 for a repayment deal. The difference being some £123. Naturally once a mortgage surpasses £200,000 + the difference is considerably noticeable.

Converting over into a repayment scheme can therefore be done in stages. Lenders have become much more flexible in order to cater for their customers needs. Many are able to start off with a 25% repayment/75% interest-only then gradually build up to 50% and so on and so forth until the whole mortgage is converted over to repayment. At least by starting out in stages you will be paying off some of the outstanding balance and in turn and more importantly, you will increase your equity in the property.

If you would like to find out more information on an Interest Only Mortgage, we highly recommend you speak with a mortgage broker to help determine if this may be the best route for you to take.

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Published on September 20, 2007