UK Finance predicted that the number of interest-only mortgages set to mature during 2020 would be 54,000. Although this is a year-on-year fall of 18,000, the Financial Conduct Authority (FCA) expects the number of interest-only mortgages maturing to rise to peak during 2022, which means that tens of thousands more homeowners will be coming to the end of their interest-only mortgage terms and will need to consider their options for paying back their mortgage loan.
Up until the financial crisis of 2008/09, interest-only mortgages were a common mortgage option for those looking to buy a home. The repayments on an interest-only mortgage are often significantly less than capital and interest repayments, as the homeowner is only paying the interest on the loan and not paying back the loan itself. At the end of the mortgage term, homeowners need to pay off the initial loan.
Ideally, homeowners will be able to pay off the loan through using money generated through means such as investments, savings or inheritance. Although this is the ideal scenario, sometimes investments, savings or inheritance is not enough to cover the loan. In other cases, borrowers were not fully aware of the term of the interest-only mortgage and as a result, do not have the money needed to pay back the loan when the term ends.
Homeowners at the end of their interest-only mortgage term and who are unable to repay the mortgage loan can consider a retirement interest-only mortgage (RIO). “A RIO mortgage works in a similar way to a standard mortgage product, whereby borrowers need to make monthly interest repayments,” explained Eleanor Williams, finance expert at Moneyfacts.co.uk. “Where they differ however, is that there is no set end date or term for a RIO mortgage. Instead, payments continue until either the borrower passes away or goes into long-term care, at which point the property is sold in order to repay the debt.”
While RIOs can be a good option for those coming to the end of an interest-only mortgage term, data released by the FCA earlier this month found that just 2,291 RIOs had been sold by the end of June 2020. This is significantly less than the 21,000 the FCA predicted would be sold by 2021 and resulted in Responsible Life branding these mortgages an ‘outright failure’. Saying this, research carried out by Moneyfacts.co.uk found that since February this year, the number of RIO products on the market has increased, from 74 in February to 112 on 20 November. In addition to this, during this same period three new providers started offering RIOs, up from 18 to 21. The research also found that the average rate on RIOs, as with standard residential mortgages, has also increased, from 3.47% in February to 3.59% on 20 November.
Williams added: “It seemed to take some time for providers to react to the FCA’s directive in March 2018 to support older borrowers’ mortgage needs, and our records show that only two providers had launched a total of five RIO products by July 2018, rising to 12 providers with 38 deals available in February 2019. However, competition in this sector has increased recently; there are now 21 providers active – the highest we have recorded so far – with three lenders entering this section of the market since February 2020. Equally, the number of products available has increased by 38 to 112 since prior to the onset of the Coronavirus pandemic in February, demonstrating that there is now a higher level of choice for potential borrowers.”
While a RIO mortgage can be a good option for some borrowers, as with a standard mortgage, borrowers need to pass affordability tests to successfully apply for a RIO mortgage. For those who are not able to pass the affordability test or who want to pay off the mortgage loan when they retire, equity release could be an option.
Equity release allows homeowners to borrow a lump sum by releasing equity from their home. Normally, the equity release loan does not have to be repaid during the borrower’s lifetime unless they move into a permanent care home, but interest is added on the loan, so it can have a significant impact on inheritance left behind. Due to the long-term financial implications of equity release, borrowers should consider speaking to an independent financial adviser to ensure it is the right option for their circumstances.
Another drawback with equity release is that homeowners usually need a substantial amount of equity in their home to qualify. Usually, a homeowner will need to own 50% or more of their property’s value in order to borrow through equity release. Fortunately for many interest-only mortgage borrowers, rising house prices, combined with their initial deposit, has resulted in many owning 50% or more equity in their home. Data released by UK Finance in June 2020, revealed that 612,000 interest-only borrowers had equity of 50% or more, compared to 411,000 who had equity of 50% or less. But if property prices fall as some experts predict next year, this could reduce the number of equity homeowners own in their homes. For more information about equity release, read Is using equity release to pay off an interest-only mortgage a good option?.
Another alternative to paying off an interest-only mortgage is downsizing. Selling the property and buying a cheaper home, enables homeowners to pay off the interest-only mortgage loan and using the money on the equity gained from the property to buy a less expensive home.
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