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Interest only mortgages require monthly payments of the interest owed, with the capital amount you’ve borrowed paid at the end of the mortgage term. Once your interest only mortgage ends, you will be required to pay off the capital amount as a lump sum of money.
This guide focuses on interest only mortgages for residential property. If you are looking to purchase a buy to let property then click here for a guide that will discuss repayment strategies for buy to let in more detail.
As you are only paying the interest each month, interest only mortgages have lower monthly payments than those of repayment mortgages. With a repayment mortgage, you will pay back the interest as well as a small part of the capital amount borrowed each month.
With lower monthly payments, interest only mortgages are more affordable in the short term, keeping your monthly outgoings to a minimum. However, you must have a suitable plan to be able to pay the capital owed at the end of the term and lenders will want you to prove you have an adequate repayment plan in place.
With a repayment mortgage, your monthly repayments will be higher but at the end of the term, if you have made all of your monthly repayments, you will owe the lender nothing and own the property outright.
You can find out more about the different types of mortgages here which are applicable to both interest only and also repayment.
Use our handy calculators to compare what your monthly payments will be for an interest only mortgage and for repayment mortgage options.
Interest only mortgages were popular during the 1990s as they were seen as an easy way to get into the property market. They accounted for a third of all mortgages just before the financial crisis of 2008. Before the financial crisis, borrowers were often able to secure interest only mortgages without showing solid evidence to the lenders of how the capital would eventually be repaid.
Up until recently, it was common practice for borrowers to take an endowment mortgage which was an interest only mortgage with an endowment policy used as the repayment method. But due to investment underperformance, many endowment policies did not generate enough capital to repay the outstanding mortgage amount and those property owners are now seeking alternative ways (such as those outlined below) to repay their interest only mortgage.
It soon became clear that scores of interest only customers would be unable to pay off their mortgages and as a result, it is now much harder to obtain an interest only mortgage with lenders requiring larger deposits and approved repayment plans. According to a recent article in The Telegraph, more than 100,000 interest only mortgages will mature this year, still leaving 1.5 million outstanding.
If you are are looking into taking out an interest only mortgage, acceptable repayment plans might include:
Pension lump sums - a quarter of a pension’s value can be taken tax free
The sale of other assets such as second properties
Investment policies (ISAs, stock market investments and endowment policies)
Downsizing to a less expensive property at the end of the term
Lenders all have varying criteria and they may make occasional checks throughout the mortgage’s term to ensure that your repayment plan is still in place and on track to enable you to make the final payment.
With so many variables and because everyone’s situation is different, it is vital you get individual advice before you decide to take out an interest only mortgage. Click here to speak to one of our advisers and we can help with your decision making process.
If you already have an interest only mortgage and are looking into how you will repay the capital at the end of its term, options might include:
Downsizing your home by selling your property and buying a cheaper one so that you can use the proceeds from the sale to pay off the mortgage balance. Click here for our useful house value guide
Switching all or part of your balance to a repayment mortgage basis
Remortgaging to a better mortgage rate in order to free up money for investing or overpaying. Click here for our guide to remortgaging for further information.
Paying into an investment plan which can be used to pay off the capital at the end of the term.
The list above is not exhaustive so it is important to seek personal advice for your own situation. If you are aware of a potential shortfall in funds to repay your mortgage balance then it is imperative that you look for a solution sooner rather than later.
Although interest only mortgages do have their advantages, it has become clear that they are more risky for the average consumer and hence, less easy to obtain in recent years. If you are thinking of taking an interest only mortgage or already have one and need an alternative way to repay it, make sure you do your research or even better, speak with one of our advisers .