What Is an Interest-Only Mortgage?
What Is an Interest-Only Mortgage?
This type of secured loan is popular in the buy-to-let sector.
If you’re looking for information about interest-only mortgages and other types of mortgage, you’ll come across the term mortgage rates, which refers to the interest rates levied on mortgage products. For example, the Independent newspaper recently reported that average fixed mortgage rates are falling. That’s potentially very good news for property buyers looking for fixed-rate mortgage products, as lower rates mean there’ll be less interest to pay.
With a fixed-rate deal, the interest rate will stay the same for a set period – often two or five years. By contrast, variable rates go up and down in response to factors affecting the mortgage market, such as changes to the Bank of England base rate (i.e. the rate that applies to lenders). A fixed rate can feel reassuring, but might not give you the best deal. A variable rate may – or may not – save you money compared to a fixed-rate deal, depending on what happens in the mortgage market.
Repayment Mortgages Vs. Interest-Only Mortgages
Whether you choose a fixed or variable-rate mortgage product, the lender will want you to repay the loan and the interest.
With a repayment mortgage, this is achieved by steadily making inroads into the total amount you owe. When you make each monthly mortgage repayment, you’re paying back some of the capital you’ve borrowed and paying some of the interest charged on the outstanding loan amount. Keep up with the repayment schedule and you’ll have paid off everything you owe by the end of your mortgage term (typically 25 years).
As is the case with repayment mortgages, interest-only mortgages are secured against property and available with fixed and variable rates. But they work rather differently to repayment deals and can be more advantageous in certain circumstances, as we’ll explain. For example, many buy-to-let mortgages are interest-only.
The key difference between a repayment mortgage and interest-only mortgage is that with the latter you’re just paying off the interest month by month. You don’t repay the loan itself until your mortgage term ends. This could be in as few as five years or as many as 25, depending on what you and the lender have agreed.
Short and Long-Term Considerations
A major advantage of interest-only mortgages is borrowers pay lenders less each month than they would do with comparable repayment mortgages. Some hypothetical figures from consumer body Which? put this into perspective:
A property buyer with a £250,000 interest-only mortgage charging 3% interest over 25 years would pay £625 per month.
If that person had a repayment mortgage with the same value, interest rate and duration, they’d pay £1,186 per month instead.
Taking the interest-only route can be helpful if you need to pay for home improvements or other significant expenses. Getting an interest-only buy-to-let mortgage could mean you have enough spare cash each month to update the property. You may then be able to increase your rental income.
The benefits of interest-only mortgages, when considered on a monthly basis, are compelling. However, it’s also important to look at the bigger picture and seek independent mortgage advice if you need help. You’re likely to pay more in total than with a repayment mortgage, as the interest will always be charged on the full loan amount; you’re not reducing that amount each month. Plus, when your mortgage term ends, you’ll have to repay the loan in one go.
The Importance of Having a Repayment Plan which is acceptable to the lender
From the outset, you’ll need a robust repayment plan (or ‘repayment vehicle’) that shows the lender how you’ll raise enough funds to ultimately clear the loan. The plan might involve withdrawing money from your savings account, a stocks and shares ISA or pension, for instance. Selling the property could also be an option.
Lenders generally prefer interest-only buy-to-let mortgages over interest-only residential ones. After all, it’s more straightforward for a buy-to-let landlord to sell an investment property to repay the loan than for someone to sell their own home. As a result, interest-only residential mortgages are less common and tend to be aimed at people with high incomes.
Interest-Only Mortgages for Devon Property Buyers
‘Often, the best interest-only mortgage deals are only available through brokers,’ Which? points out.
So it makes perfect sense to get expert help from The Mortgage Shop, Devon’s largest independent mortgage broker. Our professional mortgage advisors scour the mortgage market for the most suitable buy-to-let and residential interest-only mortgage products. They can explain everything clearly, help you to choose between fixed and variable rates, and guide you through the application process.
Looking for independent advice about interest-only mortgages? Contact us today.
Standard Health Warning & Regulatory Statement
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