The return of interest-only mortgages
With house prices rising, more people are looking at interest-only mortgages – but are they right for you?
With demand for property high and rising, mortgage lenders, according to Money Facts, have reported renewed interest in alternatives to the traditional repayment mortgage, including interest-only mortgages.
Unlike a repayment mortgage, where the capital, or amount borrowed, and the interest charges are gradually paid off during the course of the mortgage term, an interest-only mortgage only requires you to pay the interest on the amount you’ve borrowed. By the end of the mortgage term, you would need to pay the amount you borrowed in full.
Before the financial crisis in 2008, interest-only mortgages were hugely popular, especially since many lenders did not require customers to show how they would repay the loan. Typically, these interest-only mortgages were taken alongside endowment policies and/or unit trusts.
The strategy was that these investments would deliver returns higher than the cost of the mortgage – so by the end of the term, customers would have enough in their investments to pay off the capital.
But when the crisis hit and stock markets tumbled, thousands found themselves at a loss and struggling to find a way of paying off their debt.
As a result of the credit crunch, lenders and regulators created stricter criteria for loan applications, such as imposing minimum income levels and a robust repayment strategy to ensure the debt is cleared by the end of the mortgage term. However, buy-to-let mortgages are the exception, as landlords often elect interest-only debt and lenders grant them on the basis of the loan-to-value rate of the property.
In any case, if you don’t have the cash to pay the mortgage when the term ends you’ll need to take out a new mortgage or sell the property to pay off the debt.
What’s the difference between a repayment and an interest-only mortgage?
For many, an interest-only mortgage is convenient – but that convenience comes at a cost.
For example, if you borrow £1m on a 3% interest-only mortgage with a 10-year term, your annual interest will be £30,000 – so your monthly payment is £30,000 divided by 12, or £2,500.
Over 10 years this will mean you pay £300,000 in monthly payments, and you’ll also have to repay the £1,000,000 – making a grand total of £1,300,000. (Please note, this is subject to interest rates not changing. We work off a daily interest rate basis.)
By contrast, with a repayment mortgage you also pay off some of the capital sum with each monthly payment. The same £1m loan as a 3% repayment mortgage with a 10-year term would cost you £9,656.07 per month.
At the end of the 10 years, you’d have repaid a total of £1,158,728.40. (As before, this calculation is subject to interest rates not changing. We work off a daily interest rate basis.)
Are interest-only mortgages still available?
If you meet our eligibility requirements, you can apply for any of our residential, offset or buy-to-let mortgages on an interest-only basis. You need to check regularly that your repayment plan is on track. Your home may be repossessed if you do not keep up repayments on your mortgage.
As a responsible lender, and before lending money on an interest-only basis, we'll want to see that you have an approved repayment strategy in place.
A few examples of acceptable repayment strategies are: sale of mortgaged property, appropriate cash holdings, professionally managed diversified financial assets, and secondary residential properties.
For eligible Wealth Management clients, we offer an interest-only mortgage with an actively managed discretionary investment portfolio as the repayment strategy.
For example, as a Wealth Management client, if you borrow £1m on an interest-only basis, you could have as your repayment strategy a discretionary investment portfolio with a minimum £1.5m balance. This investment is not ring fenced or charged. Please note that the value of your investment can fall as well as rise and you may get back less than what you invested.
Could you get an interest-only mortgage?
- You’ll need to earn at least £75,000 a year if applying alone
- For joint applications, one of you must earn at least £75,000 a year, or your combined income must be at least £100,000
- We’ll tell you how much you need to provide as a deposit when you apply for an interest-only mortgage. Our current criteria for an interest-only mortgage allows a maximum 75% loan to value (LTV)
- You’ll need to show how you intend to repay the amount you borrow by the time the mortgage term ends
- You cannot rely on selling the property to provide the money required, as its value can decrease, and can result in negative equity, where the value of the property falls below the outstanding balance of the mortgage.
Please note that these criteria can change at any time without advanced warning. Your home may be repossessed if you do not keep up repayments on your mortgage.
Interest-only mortgage best practice
If you have, or are considering, an interest-only mortgage, you need to ensure you have the funds available to repay the capital at the end of the term. Here are the top five tips to managing your interest-only mortgage
- Re-mortgage to a better mortgage rate, switch to a repayment mortgage and repay the loan over a longer term to make monthly payments more affordable. Your monthly payments may be higher but as long as you keep up the payments, you can be sure that your debt will be repaid in full at the end of the term
- Consider initiating a long-term investment plan, where your invested funds can be used to pay off the capital at the end of the term. Speak to a professional financial advisor to make sure your plan is suitable for your needs. The value of your investments can fall as well as rise and you may get back less than what you invested
- Consider making lump sum overpayments or set up regular overpayments on your mortgage (if your lender allows this) to reduce your debt. But please do take note of the annual repayment limits in order to avoid overpaying and incurring Early Repayment Charges (ERCs)
- If you think you may not be able to pay off the loan when the term ends, act now, even if you are several years away from the end of term. The longer you wait, the fewer options you’ll have, so it’s important to seek financial advice as soon as possible
If you're interested in talking through your mortgage options, including interest-only mortgages, please contact your Wealth Manager or a representative of the Barclays Wealth mortgage team.
Subject to application, financial circumstances & borrowing history. Terms and conditions apply.
Prepared by James Peto, Mortgage Team leader, and Liam Boardman, Senior Wealth Mortgage Specialist.
Things to consider
Your home may be repossessed if you don't keep up repayments on your mortgage.
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