Interest-Only Mortgages

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Interest-Only Mortgages

Interest-Only Mortgages

Richard Campo talks us through interest only mortgages.

Podcast was accurate at point of publication and is subject to change (June 2023)

What is an interest only mortgage – and can you still get interest only mortgages?

You can very much get interest only mortgages. Whether it’s right for you is down to three factors: your income, your level of deposit and how you’re going to pay the loan back.
We’ll expand on those points as we go.

The magic number in mortgages is having a 25% deposit. If you’ve got that, you can definitely do interest only, subject to the other parts. The minimum is 15% with a couple of providers. If you put down a 50% deposit it becomes much easier.

In terms of what an interest only mortgage is, it’s very simple. If you borrow £100,000, that loan is still outstanding at the end of the term. Each month all you do is pay the interest that accrues on the account. That’s why how you repay the loan is so very important.

What’s the difference between interest only and repayment mortgages?

Repayment is the traditional mortgage. That’s what more people are used to, where every month you pay some of the interest and some of the capital of the loan. Typically a mortgage might be over 20, 30, even 40 years. You make all your payments, and at the end, the mortgage is paid off in full.

A repayment mortgage is our default recommendation because it’s less risky and saves you on interest. But if there’s a good reason for doing interest only, we can – and also you can mix the two, which I’ll come on to in a moment.

How much do I need to earn for an interest only mortgage?

As always, there’s no straightforward answer in mortgages, but if you earn £75,000 individually or you have a household income of more than £100,000, the majority of lenders will play ball.

The logic is that if you’re more affluent, you have more ways of repaying the loan. However, some banks have no minimum whatsoever – and some banks have higher ones.

What are the terms for an interest only mortgage?

If you mean terms as in the interest rate charged, that is pretty much the same as any mortgage. The structure of a mortgage is either interest only or repayment, and the interest rate normally sits aside that. If you can tick the criteria boxes, you get the same rate as advertised by the lenders.

The other definition of ‘term’ is how long the mortgage is. The maximum term for interest only tends to be 25 years – very few banks offer longer than that. Many banks require the loan to be paid off by the age of 65 or 70. Beyond that is a whole separate type of lending which again I’ll come on to later.

Are Buy to Let interest only mortgages available?

Yes and in fact with Buy to Let that’s the default. The property is seen as an asset itself, so the regulator is less concerned because it’s not your home. You can sell it to repay the mortgage.

Most landlords do set the mortgage up that way. If you want to know how loans are assessed, see the Buy to Let podcasts on our website. In brief, there’s a calculation for how much a bank will lend you, and it’s all to do with the monthly interest charge. It’s called an ICR – an interest cover ratio – and that is much easier to achieve on an interest only basis.

Are interest only mortgages available for the self-employed?

Yes. As long as a bank is willing to offer you the loan and you’ve got the right income and deposit, there’s no differentiation for the self-employed. There are a couple of niche providers that offer self-employed mortgages, but some high street banks are really good at this anyway.

You could argue that they’re more suitable for the self-employed as your income fluctuates. Some months it’s a bit easier to pay more. Plus, some people have what’s called a ‘liquidity event’ – you might sell your business, for example, and that could be a great way of paying off the mortgage.

Can a First Time Buyer get an interest only mortgage?

Yes, as long as you tick those boxes. There’s no differentiation for a First Time Buyer. It’s all about income, deposit and repayment method.

Can I make a joint application for an interest only mortgage?

Yes. But the thing I would point out is that both of you need to meet the criteria. It’s really important to understand how banks determine income and this does come up quite a lot.

Say, for example, a bank says you need £100,000 income for an interest only mortgage. You earn £50,000 basic and a £50,000 bonus. They might only accept half of the variable income and assess you at £75,000 – even though your P60 might state £100,000.

So you’ll need to be careful on joint applications to make sure you both tick the boxes. But that’s exactly why we’re here, so you don’t have to worry about that.

Can I get an interest only mortgage with bad credit?

Perversely, banks are actually more amenable on this. If you’ve had bad credit in the past, you tend to get charged a higher interest rate. If it’s not a major thing, or it was a few years ago, you can soon go back to the high street lenders and get a lower rate.

For the first couple of years, where you’re paying a higher rate it could make sense to go interest only to keep the payments down, then move to repayment at a later date.

There is fluidity around this. Just because you start on one route doesn’t mean you have to finish that way. You could start repayment, then go interest only – and you can mix the two as well.

What are the pros and cons of an interest only mortgage?

The main pro is that it’s cheaper. The monthly payments will be lower because you’re just paying interest. That flips into the direct con that you’re not paying the loan off – so it is more risky.

You have to have a viable repayment method. A lot of banks have strict criteria here, that you need to have assets, shares, a pension, a property or income at a certain level. There are lots of different ways you can repay a mortgage, but you need to show you have a viable repayment method. You need to state what you will do over the next 10, 15 or 20 years to raise that money. We need to evidence that it’s suitable and low risk.

Another pro is that there’s fluidity around it. It could be suitable to do now and we can always change it later.

How long can you stay on an interest only mortgage?

The maximum term tends to be 25 years from the outset of the mortgage. The age limit is typically up to 65, sometimes 70. If you’re young and start out on this route, technically you can have longer. You could remortgage a few times beyond 25 years. But once you start butting up against retirement ages, the rules change.

Can you extend the term of an interest only mortgage?

We just touched on the fact that you can extend by remortgaging. It’s really about your retirement age and how long you can work for.

If you’re a bricklayer, you’re probably not going to be paying a mortgage in your 70s doing this job. But I have a client who is a psychotherapist from Austria who is working at this age – so it really depends what you do for a living.

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Can you pay off an interest only mortgage early?

It depends on the product. Whether it’s repayment or interest only is down to the structure. How you pay it off is about the product. Most lenders let you pay off 10% of the mortgage balance each year without any penalty. Some let you do a bit more.

Then some banks give you flexible products where you have no penalty whatsoever for overpaying – you can pay more or you could offset. Overpayment is more of a product conversation than an interest-only conversation – we will deal with that in selecting the right product for you.

What happens when my interest only mortgage expires?

This is all about the end of the term. If you’re creeping up toward retirement age there are a couple of different options.

Ultimately, you could sell the property, pay off the loan and buy a property with the equity. That’s what most people plan to do. We’re London-based and very rarely do we deal with clients who were born and raised in London. You might move back home – or typically all our clients seem to move down to the South Coast – you buy a nice bungalow on the sea front and you’re sorted.

But if you want to carry on paying the loan you can get a RIO mortgage, which stands for retirement interest only. With my example of the psychotherapist client, if he wanted to keep paying his mortgage he can evidence his income and get one of those.

Or you could move into the equity release world. You keep the loan interest accruing and then pay it off when you die. That’s a big, separate topic in itself. But at the end of the term you can start looking at those options.

Fundamentally, as long as you can keep paying the mortgage and stay in the property, you can. We just need to decide how we go about it.

What are my options if I can’t repay the capital of an interest only mortgage?

You might want to refinance. Perhaps your specific lender won’t go past age 65. It might be a case of doing one of those mortgages I just mentioned, because it will give you more time.

Or, it may just be you have to sell the property and downsize – and that’s where the risk comes into it. You have to go into this with your eyes open. If you don’t pay the loan off or have the means to pay it off, the lender will at some stage tell you to sell the property to pay them back, or you take a different scheme.

Will the lender repossess my home?

It’s very unlikely you’ll be in that situation. Once you come to the end of the term we can restructure the loan, we can refinance, we can do all sorts of things.

With lending, if you keep paying, banks are going to work with you. This comes up more and more as house prices keep going up and everything gets more expensive. We have many clients with mortgages in their 60s and 70s.

Lenders are very amenable – they will go outside their standard policy if there are viable repayment routes and they can see your income. It won’t be that on your 65th birthday the bank will repossess your property. We’ll make sure that doesn’t happen.

Can I get an interest only mortgage at age 60?

Like I just said, this is coming up more and more. A big theme in the property market now is that downsizers can’t find anywhere to move to. They can’t find suitable property. There’s not a lot around at the minute.

So people think, rather than sell, can I stay here? As long as you’ve got the equity, as long as you got the income, there are lots of options around this. Age is much less of a factor.

As always it goes down to your specific circumstance and we will always try and find you the most cost efficient route. Equity release is not this bad thing. It’s much better to stay in a property than not. But that’s very much the end of the curve, there are lots of ways we can keep you in your home.

Can you claim back on an interest only mortgage?

Sadly not, not even on Buy to Let these days. You can thank the government for that. The only way you can offset interest on a mortgage right now is if you buy the property through a limited company as an investment.

But this kind of thing changes with the Chancellor’s budget – something major goes on almost every year at the moment, so that may well change. But as we sit here today, no. [Podcast recorded in June 2023]

How do I get an interest only mortgage?

Get advice. This is a world that gets more and more complicated. Prior to the financial crisis in 2007, there were 100% interest only mortgages and none of these rules to worry about. Today it is complicated, and it is risky.

Talk to a broker and get advice. The application process itself is the same as anything, and that’s why we talk about the structure and the products – they go hand in hand. But I cannot emphasise enough how important it is to get advice because you don’t want to get to the end of the term and say ‘I didn’t know that I can only borrow until this point’. Let’s deal with it all at the front end and make sure you’re comfortable.

Brokers often have exclusive deals that aren’t available to the public. We have access to specialist lenders in more high-risk areas. Banks are happy to outsource the advice to us. We deal with your situation and find you the most appropriate lender.

Don’t think that just because you’ve gone to your bank and they said no, you can’t do it. It’s just that specific bank’s criteria. We have hundreds of lenders to choose from and thousands of products. So talk to us. We will find you the best way to get this done.

Content was accurate at point of publication and is subject to change (June 2023)

Your home may be repossessed if you do not keep up with your mortgage repayments.

The Financial Conduct Authority does not regulate most Buy to Let Mortgages.