An interest-only mortgage is a mortgage plan where you pay interest each month before paying off the full amount borrowed at the end of the loan period. Read our quick guide below what an interest-only mortgage is, how it works, and what the possible advantages and disadvantages are to them.
How Does an Interest-Only Mortgage Work?
When you take out an interest-only mortgage for your flat or house, your monthly payment will only repay the interest charges on your loan. You won’t need to pay back the amount of borrowed money until the end of the loan term. At the end of the loan period, you will still owe all of the original capital borrowed and have to repay this in full to the lender.
What Is Different About an Interest-Only Mortgage?
With traditional mortgages, you will pay back a percentage of the loan amount plus interest each month throughout the loan period. This will usually be divided into equal instalments. If you meet all of your repayments, the entire loan is paid off by the end of the term.
However, with an interest-only mortgage, you will pay only the interest in monthly payments – so you will still owe the original sum borrowed at the end of the term!
What Are the Advantages of Interest-Only Mortgages?
One of the main advantages to an interest-only mortgage is that they are cheaper in monthly payments. Read our short list below to the advantages to interest-only mortgages:
- Cheaper monthly payments
- Only paying interest, freeing up more money
- Easier and more manageable payments
- More money to set aside from your monthly income
Interest-only mortgages have advantages which may suit you. For example, if you have an interest-only mortgage of £200,000 over 25 years, with a 3% interest rate, you will pay £500 each month. You would need to pay nearly double that, £948 each month, with a standard repayment mortgage.
What Are the Disadvantages of Interest-Only Mortgages?
While an interest-only mortgage does make monthly payments more affordable, you will have to end up owing the full amount at the end of the loan term. As per our above example, if you pay £500 each month for 25 years, you’d still owe the lender £200,000. Because of this, the sum is not divided which might be harder for you to pay off.
Some of the disadvantages of interest-only mortgages:
- Added pressure to repay
- May need to sell your house fast or your home could be repossessed if you cannot complete your mortgage repayment
- By the end of the period, you won’t own the property outright
- Difficult to qualify for as a first-time buyer
What Happens If You Cannot Pay the Mortgage at the End of the Term?
If you cannot afford to repay your interest-only loan, your home may be repossessed. If you reach the end of the loan term and don’t have the money, you may consider taking out a new mortgage or selling the property.
If you’re worried that you won’t be able to pay your interest-only mortgage, you should act now. Seek financial advice as soon as possible. Don’t wait until it comes to the end of the loan term; the longer you leave it, the fewer choices you’ll have.
Should I Get an Interest-Only Mortgage?
If you’re buying a property and thinking about getting an interest-only mortgage, there are some things to consider to help you stay on top of your loan. Here’s some advice to help you feel secure in knowing that you’ll be able to afford your mortgage repayment.
Switch Your Mortgage
You may consider switching your interest-only mortgage to a repayment one. While this will increase your monthly payments, you won’t need to worry about paying off the large lump sum at the end of the term. You may even find a better mortgage rate or an option to repay over a longer period for more affordable monthly payments.
An Investment Plan
Some people pay into an investment plan during their interest-only mortgage term. You can then use this to pay off the money at the end of the mortgage period. A financial adviser will be able to suggest a suitable plan.
