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Interest Only Mortgages

Interest Only Mortgages

Category: Mortgages

Updated: 31/10/2008
First Published: 11/10/2006

This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

With house prices at record levels many people are struggling to get onto the property ladder. Even those people who have sufficient income levels to get a mortgage are struggling to find a mortgage option that they can afford to repay.

Many people are taking out their mortgage over a longer term. Traditionally the typical mortgage term has been 25 years. However, an increasing number of people are taking out their mortgage over up to 50 years. This may be on the hope that their financial situation will change and so they can reduce this term. But people must be aware that this could mean they are still repaying their mortgage into retirement.

Another option many people are taking is what is termed an interest only mortgage. This means you are not repaying any capital borrowed. For instance, if you borrow £150,000 over 25 years, your monthly repayments will only cover the interest on your mortgage, making them cheaper than a traditional repayment mortgage. However, at the end of 25 years you still owe your mortgage lender £150,000.

With an interest only mortgage an investment product such as an ISA is also taken out at the same time. The aim is that this investment will at least cover the amount of capital that is owed at the end of the term. Hopefully, there will be some money left over. However, those of us familiar with the endowment mis-selling claims will know that there is no guarantee that this investment will grow enough to cover the capital owed.

However, with people struggling to afford their monthly mortgage repayments, many people are not even taking out any form of investment with their interest only mortgage. According to the Council of Mortgage Lenders, 15% of first time buyers and 22% of home movers are taking our interest only mortgages without an investment.

Once again people taking this option are banking on their financial situation changing meaning they can eventually afford to take out an investment vehicle or switch to a capital and interest repayment mortgage. This is all well and good but if this time never comes people will find themselves in severe financial difficulties.

The jump from interest-only to capital repayment can be a huge. You can soften the blow by using the option of partial repayments which many lenders now offer, allowing you gradually to build up the percentage of the capital that is paid at a rate comfortable to their circumstances.

An alternative option, providing low initial repayments would be a fixed or discounted deal with extended tie in, but although these rates of say 1.89% may appear attractive, the exit fees, set up fees and higher rate during the tie in period could soon take a shine off those very attractive low monthly payments experienced during the first couple of years.

While interest only may be the only option for you to be able to step on to the property ladder, in order to prevent major problems in the longer term, the mortgage market needs to ensure people are fully aware of their situation, the consequences of just paying the interest and the true cost of fully paying off the mortgage. You perhaps should receive regular advice and documentation, detailing your position and the costs/risks you may face.

Disclaimer: Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at any time.

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