When looking to buy a property, you may be under the assumption that when you get a mortgage any and all payments you make go straight into paying off chunks of that property until you own it outright.
However, there are two types of mortgage you can apply for as a potential borrower, interest only and repayment. Which option you take is dependent on your individual circumstances and what is best for you.
This article focuses on interest only mortgages and how they work as opposed to repayment mortgages.
What’s the difference between an interest only mortgage and a repayment mortgage?
The difference between the two type of mortgages you can purchase are vast and need careful consideration before you decide which options are best for you (including whether you take a fixed or variable rate interest).
To start, a repayment mortgage is probably the most conventional and widely available method of repaying a mortgage. It means you can pay back the capital (loan) and the interest together and the loan amount will gradually reduce over the term. Your monthly payments to your lender will therefore be made up of both capital repayment and the interest on your loan. As a consequence of this your payments will be higher but at the end of your term you will own your property outright.
An interest only mortgage however is pretty much what it says it is. When you take out an interest only mortgage the payments you make every month cover the interest on the loan as set by your lender. You won’t pay any of the capital back on the loan itself until the end of the mortgage term. This means that you won’t own your property outright until you have paid back the capital. As you are required to pay the total capital back to your lender, you are therefore required on application to provide proof that you will be able to afford this repayment.
What are the advantages of having an interest only mortgage?
Depending on your circumstances there are advantages to having an interest only mortgage:
- Lower monthly payments – You are only paying the monthly interest on loan and no payments on the capital.
- Investment flexibility – You decide how you are going to repay the mortgage so can use the money you save on repayments to invest into stocks/shares or put it into savings.
- Possible profit – If your investments work well you may be able to pay off the mortgage and have a lump sum to with as you see fit.
What deposit will I need to put down?
Your mortgage approval is based on a level of risk. Lenders who offer interest only mortgages therefore have strict lending criteria. This will affect your deposit requirements as these lenders will ask for a minimum of 15% deposit.
How do I afford to pay back the capital at the end of the term?
You will need to make arrangements to cover the capital owed at the end of the term of your mortgage, this is referred to as a ‘repayment vehicle’. You are required to provide proof of your repayment vehicle on application for your mortgage.
Repayment vehicles can be set up as an investment or you could use an existing asset (to the value f the loan). Either way plans need to be legitimate and your lender will assess whether your chosen method of repayment is likely to pay off the mortgage at the end of the term.
Examples of possible repayment vehicles could be:
- Stocks and shares investments
- Savings especially those in ISA’s
- Existing property or asset
What if I can’t pay off my interest only mortgage at the end of its term?
As with any mortgage, if you fail to keep up with your repayments your lender could repossess your property.
However, if you’re coming to the end of your deal and have concerns that you may not be able to pay off your mortgage the first thing you need to do is speak to your lender.
There are options available including:
- Extension to your term
- Switching to a repayment mortgage
- Selling your property or any other assets
- Making overpayments (within your terms)
How a mortgage advisor could help
Interest only mortgages aren’t for everyone. But if you are considering it we know that helpful and insightful advice can help with any concerns and questions you have.
Mortgage advisors will help borrowers understand their options and will also match lenders to their clients based on their personal circumstances. A whole of market broker will also have access to high street lenders right through to specialist lenders.
Rather than trawling the high street and agonising over your choice, you could save time and potentially a large amount of money.
Contact us at Online Mortgage Guru on 0345 3669799 or email us via email@example.com and we will put you in touch with a suitable specialist to handle your enquiry.