Property When is an interest-only mortgage right for a client?

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I think the interest-only mortgage must be the most misunderstood concept in the mortgage industry. Often blamed for all the woes in the market, this niche product has had plenty of bad press over the years. During a mortgage interview, I find it interesting to watch the reaction of many young clients that have heard horror stories from the older generations when these words are mentioned. There’s no doubt that these products have been mis-sold over the years and I do understand people’s natural aversions.

 

For the vast majority they are not the right choice, however; on occasion, I do come across a client where an interest-only mortgage will be a fantastic way to achieve their goals and fit around their remuneration structure. For example, where a client earns a £100k base salary and has a £300k total compensation package – i.e. their discretionary bonus exceeds their guaranteed income.  The first thing to say is interest-only is not a shortcut for a client that can’t afford the capital and interest monthly costs to still achieve their goals. All the same, income multiplier rules apply, this is regardless of the repayment method selected by the client. This means you can’t borrow more if you choose to go down the interest-only route. Interest-only is simply a way for a financially astute client to structure the repayment of the mortgage in a way that suits their financial circumstances.

 

Average broker statistics will show that most barely use interest-only mortgages. Since many of our clients are based in the city, it’s a method we use a lot. Part and part mortgages are a hybrid of the two which involves an element of repayment combined with interest-only. These are very popular with my client base. For example, let us consider the case of a 40-year-old client who has a 15% deposit and wants to make the step to the elusive £1m home. Most of our clients receive a basic salary, but their bonus can often be more than the basic and that bonus comes typically at the start of the year.

 

For a client wanting to borrow £850k to buy a new home on a repayment basis over a 25-year term, the monthly payments based on a two-year fixed rate of 1.74% would be approximately £3,496 per month. That is broken down as follows: -

Purchase price

Deposit

Rate

Term & Method

Total PCM payment

Repayment Element

Interest Element

£1,000,000

£150,000

1.74%

25 years

Capital and Interest

£3496

£2262

£1234

 

 

 

 

 

 

 

 

A basic salary of £100k per annum means take-home pay assuming no additional payslip deductions of approximately £5,544, so £3,496 from that figure does not leave a lot of spare cash for the day-to-day living costs. These can, of course, be taken out of the annual bonus if the client is disciplined enough to save some or all of the bonus and pay it to themselves on a month to month basis. In reality that seldom happens.

 

What a lot of clients (and even brokers) don’t seem to know is that with some lenders we can bring in an element of interest-only to reduce month to month costs. Here’s how that would look: -

Purchase price

Deposit

Rate

Term & Method

Total PCM payment

Repayment

Element

Interest Element

£1,000,000

£150,000

1.74%

25 years

Part and part

(£500k interest-only and £350k repayment)

£2164

£932

£1232

 

This method is known as “part and part”. Until recently this was capped at 75% Loan to Value (LTV) by most lenders, with a couple of bespoke lenders going to 80% LTV. However, due to recent positive changes in the market, this method is now available at 85% LTV. This works well for clients that often receive an annual bonus which works out more than their basic salary, as well as clients that receive a monthly bonus or commission that can fluctuate, both of which are common with our clients working in the City.

 

Most high street lenders allow a mortgage overpayment of 10% of the balance per year without penalty, with unlimited amounts being allowed to be overpaid at the end of the fixed-rate period. I must stress, the client is responsible for tackling the interest-only debt themselves – again often from bonuses. This is because the debt on the interest-only part of the mortgage will never be repaid otherwise. I explain to clients that we do not want to store up problems for the future.

 

The key is getting the right advice from a broker that understands the City market and the way financial professionals are remunerated, which could be the difference between getting the home of your dreams, or not. That’s where my team can help you work out what the options are with a no-obligation discussion.

 

David Baker – Latest Blog Posts

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