If you are one of those households staring down the prospect of unaffordable monthly mortgage repayments, one option is to go interest-only.
Massive before the 2008 financial crisis, interest-only mortgages in which the borrower only repays the interest on the loan can almost halve a household’s mortgage repayments.
In the run-up to the financial crisis borrowers were signing up for huge interest-only mortgages with no prospect of ever being able to repay the amount borrowed. The new affordability tests introduced post-crash all but did for them.
Despite that, they have returned to product lineups in recent years. The problem for many will be the fact that lenders are now very choosy about who they give them to, says David Hollingworth, an associate director at the broker firm L&C Mortgages.
In pure repayment terms, they can be a godsend – if you can fulfil the criteria. A £200,000 repayment mortgage (over a 20-year term) at 5.5% will cost about £1,376 a month. If you were able to switch to an interest-only deal, the monthly payments come down to a much more manageable £917. Someone with a 15-year £400,000 mortgage will see their payments almost halve from £3,268 a month on a repayment deal to £1,833.
“Going interest-only can work but only for the right kind of borrower, someone with a good financial history of repayments, someone with plenty of equity in their home who is just looking for some breathing space,” Hollingworth says.
One of the main aspects of interest-only is that borrowers are not repaying the debt. Those taking out a £200,000 five-year interest-only mortgage still owe £200,000 at the end of the five-year term. This might not be a problem at 30 but it can be for older people.
“Lenders want to see evidence of a repayment plan, and they tend to only offer this option to those who have built up significant equity in their home. For example, Barclays will only offer interest-only deals to those [with equity of] at least £300,000. Other lenders will also want to see that the borrower owns a decent proportion of their home. This requirement will rule out quite a lot of borrowers from going down this route,” Hollingworth says.
A quick look at Moneysupermarket.com suggests there are plenty of interest-only deals out there – if you have the equity. Someone hoping to borrow £400,000 against their £600,000 home has a big choice of providers, with the Cumberland building society offering the lowest rate at 4.59%. However, try to borrow £500,000 against the same home and all those offers disappear.
So who will interest-only work for? The ideal candidate will be a borrower with a good history of making their repayments over a number of years, who has significant equity in their home. In reality, they are likely to be higher earners or those who bought some time ago. It appears that borrowers typically need to own at least 25% of their home, to go down the interest-only route, but it will depend on individual circumstances.
Hollingworth says going interest-only over a short period would, in his view, be preferential to staying on a repayment mortgage but extending the term to 30 years or longer – provided you have a plan to make up the repayments shortfall.
In terms of the rate borrowers will pay, which is typically now 4.5% to 6%, they should get virtually the same terms as those taking out a repayment deal.
Another option is to go for a part-interest-only deal. Hollingworth says some lenders will allow borrowers a 75% interest-only option with the rest on repayment terms. This could be the difference between being approved for an interest-only deal or not.
Last, don’t forget your existing lender. Lenders stand ready to help anyone struggling with their mortgage payments, with a temporary switch to interest-only an option.
