Interest-only mortgages are often a taboo subject. Rhys Edwards talk about the advantages and disadvantages.
The advantage of interest-only is that the monthly payments for the mortgage are significantly lower than a repayment mortgage. The disadvantage is that with only the interest charge being paid each month, the outstanding debt will not reduce.
Interest-only mortgages can suit those who have alternative ways of repaying a mortgage. Typical repayment methods include annual bonuses, investments, pensions, sale of property and more.
One group that I’ve seen this work well for is my City clients who earn annual bonuses. The interest only provides a lower monthly payment, with the annual bonus then being used in lump sum overpayments, reducing the outstanding capital over the years.
Mortgage interest rates are currently so low that some clients are using this to their advantage. By increasing contributions to investments with a high rate of return whilst having their mortgage on an interest only basis, they plan to use their investments to repay the mortgage at the end of the term. Of course, this is a riskier approach as investment return isn’t guaranteed, but it can be an option for the less risk-averse.
Interest-only mortgages can also work for shorter-term borrowing if there is a plan to sell the property within a year or two.
If you hope to use the sale of the property to repay the mortgage, you will be limited to borrowing a maximum of 50% of the property value on an interest-only basis. If you have other investments, equity in other properties and/or large pensions these can be used to support up to 75% interest only lending.
Not everyone is eligible for an interest only Mortgage
Interest only mortgages are not as readily available as they once were, with only a small proportion of banks now offering them. For the banks who still offer these products, there are a number of specific lending requirements. This includes:
Having a minimum amount of deposit or equity
A minimum level of income for applicants
An accepted repayment strategy, for example sale of the property, investments, pension etc.
Unless you meet their strict criteria, you are unlikely to find a lender.
Interest only mortgages for buy-to-let properties are still readily available on up to 75% of the property value as it is widely accepted that these properties will be sold to clear the outstanding balance at the end of the term.
This is a recent example of a buy to let mortgage arranged for one of my City clients.
My client is in full-time employment, earns a basic salary and also receives a performance-based annual bonus, both of which meet the lender's requirements. My client was also an existing homeowner.
He wanted to buy a new home for the family, however, the new property was in need of renovation and improvements before the family could move in. This meant that the client would be staying in his current home for up to 12 months, whilst purchasing and renovating the new property. The client’s income would support both mortgages but as my client wanted to invest more disposable monthly income into the renovations rather than in higher monthly mortgage payments, interest only was the perfect option during the short renovation period.
The client's monthly mortgage payments were significantly lower compared to a repayment mortgage, which enabled the client to invest more in getting the new property finished on schedule. Once the renovations were complete, the existing home was sold and both mortgages were settled, with a small remortgage remaining on a repayment basis.
This approach ultimately saved my client over £3000 per month during the works and increased disposable income while balancing the costs of owning two properties. The mortgages were then paid off with the sale of the previous home just over 12 months later. My client was left with a small amount on a repayment mortgage at a very comfortable monthly cost.
If you would like to know more about interest-only mortgages, please do get in touch and we will be happy to discuss your options and requirements.