interest-only mortgage

What is it?

With an interest-only mortgage your monthly repayments only cover the cost of the interest charged on the money you have borrowed. At the end of your mortgage term, if payments are kept up to date, you will still owe exactly the same amount that you borrowed.

You therefore need to make separate arrangements to repay this capital sum. You could build up the required lump sum by making payments into a savings or other investment scheme. You could also plan to use capital from somewhere else like a pension scheme, an inheritance or the sale of another property or business.

What does it offer?

An interest-only mortgage offers lower monthly payments.

When is it worth considering?

This kind of mortgage may suit you if you intend to sell the property before the end of the term and clear the capital debt from the sale proceeds. If you are a buy to let investor, buying the property as a second home, or are planning on buying something smaller or cheaper an interest-only mortgage is worth considering.

If your earnings are low now, but you expect them to be much higher in future, once you’re fully-qualified or trained, an interest-only mortgage might be a good option for a couple of years before you convert to a repayment mortgage.

The repayment element of a repayment mortgage can be regarded as a savings vehicle which offers a tax-free return equal to the interest rate on your mortgage.  When interest rates are low, you might feel you could beat this return by investing this money elsewhere - an interest-only mortgage gives you the freedom to do just that.

What should I be aware of?

The proceeds of your savings, investments or sale might not be sufficient to repay your mortgage at the time of your choosing.

Whatever the plans are that you have in place for paying off your lump sum there is some risk involved. If your savings or pension scheme under performs, or if your inheritance doesn’t materialise, you’ll still need to find the cash to pay off your capital sum.

With some interest-only deals the lender specifies the kind of investment you need to take out to cover the capital payments. There is also no guarantee that this investment will perform in the way required to pay off the capital sum.