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Are interest-only mortgages back in vogue?

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Written by:
06/07/2020
The once-maligned interest-only mortgage is suddenly looking appealing to borrowers
Are interest-only mortgages back in vogue?

Pure interest-only mortgages account for a tiny proportion of the mortgage market – just 3% of all products available, according to Moneyfacts.

However, the financial information provider found that 61% per cent of all deals in July offer an interest-only option (in addition to capital and interest). This has risen from 48% in March.

It added that an interest-only mortgage could help those hoping to reduce their monthly mortgage repayments.

What’s an interest-only mortgage?

With this type of mortgage you borrow a sum – for example £200,000 – over a set term, such as 25 years.

You only pay interest on that sum to the lender each month, so at the end of the 25 years you still owe £200,000.

In most cases you also pay into a separate investment vehicle (such as an ISA) during the same period to grow your money to repay the debt. An inheritance, or the sale of the property, could also help you repay the mortgage.

This is very different to a capital and interest mortgage, where your monthly repayment is made up of the interest charged by the lender, plus a small bit of the original amount borrowed. Over the term of the mortgage you chop away at the capital debt and it is repaid in full by the end of the term.

Of course, interest-only mortgage are cheaper each month than an an equivalent capital and interest mortgage.

Will they become popular again?

Interest-only mortgages were very popular in the 1980s but fell out of favour when it transpired that some investment vehicles – usually endowment policies – were not set to provide enough money to repay the mortgage debt, leaving many borrowers with huge shortfalls.

Lending on an interest-only basis has never gone away, but lenders now require strict evidence of how the borrower plans to repay the original debt.

They are cheaper on a monthly basis than a capital and interest mortgage, and many borrowers are looking to cut their monthly repayments as a result of being financially impacted by the coronavirus crisis.

If you’ve already taken a payment holiday and don’t think you’ll be able to afford your repayments after it ends, switching to an interest-only mortgage could be one option to cut your repayments. There are others and you should speak to your lender or an adviser to work out the best option for you.

In addition, there are 54,000 existing interest-only borrowers coming to the end of their term this year and it’s expected some will not have the funds to repay their original mortgage debt. This means they may be looking for a new interest-only mortgage.

If they are over 55, Retirement Interest-Only Mortgages (RIOs) could also be an option.

Rachel Springall, finance expert at Moneyfacts.co.uk, said: “Borrowers may well be seeking ways to reduce their monthly expenses, and an interest-only mortgage could do just that, however it is usually required for there to be a credible repayment plan in place which can entail additional monthly costs or outgoings. It is crucial then for borrowers to seek out independent financial advice to ensure it is the right option for them.

“According to Legal and General Mortgage Club, there was a significant rise in broker enquiries about interest-only options between April and May 2020. Interest-only searches by advisers were the third-highest search in the first week of May.

“As borrowers come off mortgage payment holidays, more consumers could be debating an interest-only option and using an independent financial adviser is a wise choice to find the most appropriate deal during these challenging times.”

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