Mortgage rates have really taken the brunt of inflation hikes as of late and many homeowners are feeling the pinch. Homeowners are questioning whether they can keep up with their current repayments with prices on variable, tracker, and fixed-rate mortgages skyrocketing. This has led to an increased demand for interest-only mortgages.
This year, online searches for interest-only mortgages rose 53% which just shows that homeowners are desperate to save cash somewhere, if only for a short period, and this could be the perfect, short-term solution when it comes to remortgaging, to help get through this turbulent period, until we see mortgage rates return to some sort of normality.
What are Interest-Only Mortgages?
An interest-only mortgage is a loan taken against your property whereby you only back the interest for a certain period, typically the first 5 to 10 years. During this period, no principal payments are made, meaning the loan balance remains unchanged. After the interest-only period, the loan is typically converted to a traditional capital repayment mortgage, where both interest and principal are paid in regular instalments.
Before an interest-only mortgage is granted, lenders will need evidence that you are able to pay off the full amount at the end of the term, this is usually in the form of an investment, endowment policy, or ISA and is known as your “repayment vehicle”.
Positives of Interest-Only Mortgages.
Interest-only mortgages can be extremely beneficial as a short-term solution to lower monthly payments, whether that be freeing up cash for investment opportunities, using it for financial goals, or seeing you through a financial crisis.
- Lower Monthly Payments - The most appealing advantage of interest-only mortgages is the lower initial monthly payments. By only paying the interest on your loan amount, monthly payments will be significantly lower compared to a traditional mortgage.
- Cash Flow Flexibility - Those with fluctuating income or those looking to invest elsewhere can find interest-only mortgages particularly helpful, as the lower monthly payments can free up cash which can be redirected towards other investments, debts, or financial goals.
- Short-Term Savings - If you plan to stay in your home for only a short period, an interest-only mortgage might make sense. You can benefit from the lower payments without being as concerned about the long-term implications.
Negatives of Interest-Only Mortgages.
Poor investment could lead to compounding mortgage struggles, which is why, as with any mortgage, it is important to understand the struggles and the risks you face.
- Increased Payments – you will pay more interest overall with interest-only mortgages because the amount you pay interest on doesn’t decrease during the loan term. Also, if property value declines, you could owe more than your home is worth, creating difficulties when you decide to sell or refinance.
- Balloon Payment – after the interest-only period ends, you'll be required to start paying both principal and interest. This can lead to a substantial increase in monthly payments, catching borrowers off guard and potentially causing financial strain.
- Looking After Your Repayment Vehicle – ensuring it makes enough money to pay off your mortgage. Investments, pension funds, an inheritance, or a rise in house price are good examples of a repayment vehicle but evidence is needed to show it can produce enough money to cover the full cost of your mortgage.
- Lack of Equity Building – not paying off any capital toward your loan means your ownership stake in the property is reduced and you cannot build any equity in the property.
Interest-Only Mortgages: Should You Make the Switch?
The Mortgage Charter was unveiled in June, a government-backed support scheme that enables more support for homeowners. It is a commitment on behalf of lenders to offer flexibility where required to help homeowners manage their mortgage payments in the short term, including the option of temporarily switching to interest-only mortgages via existing providers. So far, 85% of mortgage providers have signed up to the charter, including the likes of Barclays, Nationwide and Santander.
It is advisable to thoroughly examine your financial situation before making the decision to switch to an interest-only mortgage, as well as considering your future plans and risks. Ask yourself if you can comfortably afford the increase in future payments once the interest-only period comes to an end and if your income and financial situation is stable. If you have uncertainty around this, then an interest-only mortgage may not be the best option for you.
It's also a good idea to consider your long- and short-term goals. If you want to reduce your monthly payments in the short term, then an interest-only mortgage could work but if you want to focus on building equity or paying off your home over the long term then you may need to reconsider.
Lastly, some important points to consider would be understanding the market trends in your area. Are property values remaining stable or decreasing in your local area? A potential decrease in value could lead to negative equity if you’re on an interest-only plan. It’s also important to ensure you have an exit strategy and know what you intend to do at the end of your interest-only period. Do you have enough money to handle higher payments, or will you refinance or sell? Planning as far in advance prior to entering an interest-only mortgage is highly advisable.
TaylorMade: Expert, experienced, and extraordinary mortgage advisor.
We understand what a difficult time it is for any homeowner at present, and we understand in trying to find every inch of spare cash available. If you have seriously considered your options and are thinking of enquiring about interest-only mortgages, then our friendly and knowledgeable team here at TaylorMade can provide you with all the facts, figures, patience, and understanding that you need in order to make an informed decision.
We are here to guide you every step of the way and we are a mortgage broker that ensures the process of obtaining an interest-free mortgage, or any other mortgage product, is as seamless and hassle-free as possible.
Contact us today to see how we can help you.
