Interest only mortgages have made a comeback in recent years. This loan type was popular some years ago but became less available due to the financial crisis of a decade ago. Because the housing market has performed considerably better since then, mortgage lenders are now confident to offer interest-only loans to borrowers. So, is interest only mortgage a good idea?
To answer this, lets’s first answer this question: What is an interest only mortgage?
An interest only mortgage is designed to offer lenders low monthly payments that reduce the interest alone. Since you are not paying off the principal amount borrowed, the entire amount will be due for payment at the end of the term.
Mortgage lenders advise borrowers to set-up a repayment vehicle for the loan. The most common options include investment in stocks and ISAs. In a way, you are taking a gamble on your investment hoping that it will do well enough so that you can pay off the principal balance owed.
In spite of the risks, interest-only loans can work for some people as long as they can work out a solid plan for repayment.
Is an interest only mortgage better than repayment?
Interest-only mortgages can only work when there is a solid plan for repayment, be it investment of the money saved by not repaying the capital into another vehicle with higher returns or by selling the property which has the interest only mortgage against it. An action plan is neccessary as the lender needs to know how you intend to pay back the capital at the end of the mortgage term, as you would of course need to pay it back.
Is interest only mortgage a good idea for buy to let?
The main advantages of an interest only in the past were flexibility and tax efficiencies – although the amount landlords can save through tax has reduced due to new regulations.In terms of flexibility, the payments for an interest only mortgage are lower than if you are making capital repayments. Essentially, it could be a better option for buy to let, provided you have a plan to pay back the capital amount at the end of the mortgage term. Alternatively, you could sell the property to pay back the remaining capital amount. Again, this is more feasible for a buy to let property rather than the property you live in.
What are your options if you can’t pay off your interest only loan?
It is not uncommon to experience problems paying off the capital once it is due at the end of the term. However, it does not mean that you won’t have options available to work out the repayment. One of the more straightforward options is to switch from an interest only mortgage into a repayment mortgage. However, this means you’ll have to pay more on a monthly basis.
Another way to work out the repayment is to ask the lender for an extension or switch to a part repayment part interest only payment plan. In case none of these options is available, you may consider the following options:
Use the money you have put away in savings or investment to pay off the shortfall. In the first place, before you take out an interest only mortgage, you must have a robust repayment plan already in place. If you want to streamline your savings and finances, you can always speak to a financial advisor who will help you find a realistic solution to the issue.
For older borrowers, they may consider taking out a lump-sum from their expected pension as repayment for the mortgage. Most pension funds allow you to borrow 25% of the entire fund tax-free. If you do consider this option, be aware that later on, you will have less on your pension income.
One of the last resorts to consider is selling the property to pay off the mortgage debt. One of the more pressing concerns with selling your property is that the selling price may be lower than you expect and you will have to make arrangements for new accommodation after the sale.
It goes without saying that with any type of mortgage, there are always some risks involved. Nevertheless, it does not mean that it cannot work out to your advantage. With an interest only mortgage, the primary consideration is making sure that you have an excellent repayment plan at the end of the term to ensure that you won’t have to worry about paying off the capital.