The mortgage market today offers a wide range of products for your average and, not-so-average, house buyer. But just how risky are interest-only mortgages?
Whether you are a first-time buyer, multiple property owner or looking to help your children get onto the property ladder, there’s a mortgage out there for you. At least, that’s what we’re led to believe…
In fact, broadly speaking, mortgages fall into one of only two types – repayment and interest-only.
Under a repayment mortgage, your monthly payment will clear both the month’s interest on the loan and a small part of the capital. The end result being that, when the final payment is made at the end of your agreed mortgage term, you own the property free and clear.
Under an interest-only mortgage, the monthly repayments simply clear that month’s interest that has accrued, however, the capital (the original loan amount) remains untouched. At the end of your mortgage term, you will still have to repay the original loan amount, and the sum will be due to be repaid in full immediately.
Monthly repayments on an interest-only mortgage are typically cheaper than those under a repayment term. First-time buyers tend to opt for interest-only as they appear to be the more attractive, cheaper option. If finances are tight, some borrowers change their mortgage to interest-only, telling themselves at the time that it’s only for the short term and they will change back when finances aren’t so tight. People who do so are unlikely to put repayment plans in place due to the cost. Borrowers believe they will switch to a repayment mortgage when the current deal comes up for renewal, or when finances get easier. The reality is they never do because interest-only will always be the cheaper monthly option.
Borrowers that use interest-only mortgages are essentially burying their heads in the sand as to the final bill that will inevitably become due.
It is the borrower’s responsibility to ensure that they are able to repay the capital when it becomes due. This can be planned for by making regular payments into a savings account, the intention to sell the property towards the end of the mortgage term or to fund the repayment by other means. Most mortgage terms are calculated to come to an end at the same time the borrower is expected to retire.
The effect of this is that if no suitable repayment plans are in place, there will be little opportunity for the borrower at the end of the mortgage term to do anything other than sell the property to repay the loan. Not an ideal scenario if it’s your home and you want to stay. The harsh reality is, if you don’t have a way of repaying the capital loan, your property will be repossessed by the lender who will sell it to settle the loan.
What would you do, if, newly retired, you were then made homeless? This is not the rosy picture of retirement that most of us envisage.
Both financial advisers and lenders can assist borrowers by helping to put in place plans to repay the capital loan at the end of the mortgage term. In short, switching to a repayment mortgage is the simplest way forward, if this is an option.
Most importantly, don’t ignore it in the mistaken belief that “it will all be alright”. Take time to make a plan and put it in place.
If you’d like further information relating to the differences between interest-only and repayment mortgages or require a solicitor to help with the sale or purchase of your home, please contact a member of our Residential Property team for impartial legal advice. Call on 01708 229444 or email us using our contact form.This article was written by Lexie Jacobs, Legal Executive at Pinney Talfourd LLP Solicitors. The contents of this article are for the purposes of general awareness only. They do not purport to constitute legal or professional advice. Specific legal advice should be taken on each individual matter. This article is based on the law as of February 2018.