Interest only mortgage: Pros & cons | From Ask

Interest Only Mortgage

In we will talk about an interest only mortgage, you pay the interest on your mortgage each month but not the principal. Imagine paying back some of a loan and still owing just as much by the end of its term! But when you do come to pay off what you owe after your mortgage period has ended, it can be quite difficult because banks don’t tend to lend people more money once they have run out of their original family home loan. So with a £200,000 interest-only mortgage at a rate of 2.5%, you’ll make monthly repayments of £417 to cover the interest, but still have the £200,000 to repay at the end of the term.

What Is an Interest Only Mortgage?

No man or woman who tries to pursue an interest-only loan will end up turning back. Interest-only loans are a type of mortgage in which the borrower is only required to pay the interest on the loan for some time, and the principal is either repaid in payments or paid off in a lump sum at one point.

Understanding an Interest-Only Mortgage

Understanding an Interest-Only Mortgage

Most “interest only mortgage payments” can amount to the mortgage during a specific period, can be scheduled as an optional component, or could last throughout the loan. Interest-only loans normally require that borrowers just pay interest for a particular period–usually five, seven, or 10 years.

After that, the loan will convert to a standard repayment application–a fully amortized program in blanket marketing lingo–and the borrower’s monthly bills will increase to consist of both interest and a segment of the principal.

Costs of interest only mortgages

Interest only mortgages cost less per month than a full repayment mortgage due to the fact that you only pay back the interest each month. But be warned – even though monthly payments are lower, interest payments will be higher because of this.

And this means that the attractiveness of lower monthly repayments is often outweighed by the bigger financial strain that an interest only mortgage will place on you in the long run. Generally speaking, if you want to lower the cost of buying a house, then you are better off going for a standard repayment mortgage than you are by choosing an interest only mortgage.

Interest only mortgage vs repayment mortgage

An interest-only mortgage is surprisingly different from a repayment mortgage. With an interest-only mortgage, you’ll never have to pay off the principal on your loan your monthly payments are only devoted to paying down the interest on your loan. While it is substantially more affordable each month, the interest portion of your payment is usually higher than that of a regular repayment mortgage.

The alternative option, without surprise, is a repayment mortgage where you are required to pony up both the interest and some chunk of your loan balance every month until it’s brought back down to zero once again in a set number of years (This either happens at a pre-defined maximum term or after you refinance with another lender).

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According to a simple mortgage calculator, if you have £200,000 and have to pay back your mortgage over 25 years with an interest rate of 2.5%, the amount total you will pay will be £206,182.

How interest only on mortgages has changed over time

The situation concerning interest-only mortgage borrowers changed during the financial crisis when it became clear that many of these borrowers would find it difficult to repay what they owed at the end of their term because there had been no obligation on lenders to ensure that they could. Another problem was that common strategies were not working anymore and house prices hadn’t kept pace with some people’s mortgage payments, which meant they couldn’t sell their homes to put towards the balance of their loan and earn a profit.

As a result, rules have changed and in 2014, UK regulators now call for proof when something goes wrong to uncover patterns of misconduct and thereby strengthen enforcement. This effort is combined with efforts by lenders themselves who are already trying harder to ensure they only grant interest-only mortgages to appropriate borrowers.

How does an interest only mortgage work?

As with other mortgage types, interest only mortgages can be either fixed or variable. With a fixed rate you know that your monthly payments will remain consistent, no matter what may happen to the market in question. Variable rates, however, can rise or fall depending on market conditions.

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How to pay off an interest only mortgage

When you are ready to apply for an interest only mortgage, make it clear to your lender that you have a pension which you can take as a lump sum at age 55. This way, if anything happens unexpectedly in your life and you need the money early, BPI Millennium Bank will understand that this is an exceptional case and will be more willing to work with you or approve your application even if your situation changes drastically in the future. Think about bonds, shares, and unit trust too as they can also be good alternatives they may not give you instant gratification.

  • savings in a savings account or cash ISA
  • a stocks and shares ISA
  • investments in bonds, shares, and unit trusts
  • a regular savings plan, such as an endowment policy
  • a pension from which you could potentially take a 25% tax-free lump sum (at age 55)
  • separate property or assets you could sell.

What to do if you can’t repay

If you’ve realized that your interest-only payments are going to be too much for you to bear when your plan is completed, there are a few options on the table. You can talk to your lender and ask if they’ll let you extend the term of your mortgage. Doing so will give you more time to come up with the extra cash you need. Alternatively, if you want something sooner you may consider taking out another interest-only mortgage. Or for better rates but less time, switching over to a repayment mortgage may benefit you. For those who can’t stomach the higher payments, downsizing or relocating is certainly worth considering.

Types of interest only mortgages

  • Retirement interest only mortgages
  • Interest only remortgages
  • Part and part mortgages
  • Joint interest only mortgages

Advantages of interest only mortgages

A repayment mortgage means paying off the full amount of the property at the end of the mortgage term. Because interest is only paid, rather than being repaid monthly, it’s possible to have lower monthly payments, and it’s common for people to choose a repayment mortgage so they can buy a property with a higher value than they could afford on an interest-only option.

Disadvantages of interest only mortgages

You will need a substantially large deposit of around 40 percent and high earnings to get one. You’re not paying off any of your mortgage loan with your repayments, so you will still owe the full mortgage amount at the end of your term. You’ll already have or must set up a repayment vehicle to pay off the mortgage loan when the term ends, and this will need to perform as expected if you’re to avoid a shortfall.

How to apply for an interest only mortgage

If you’re looking to apply for an interest-only mortgage, you’ll be facing the same kinds of questions that anyone would have to face when they’re applying for any sort of mortgage, plus a few more. When checking if an interest only mortgage is affordable to you a lender will want to assess your income, outgoings, and anything else that can be used to ensure that you’ll make the repayments.

One will need sources of information like payslips or P60 at hand to make the best guarantee on their investment. Any future property owners should remember that one wouldn’t get off scotfree though; documents used in the application process consist mostly of bank statements or loan accounts, along with savings account data and credit card balance summaries.

Alternatives to interest only mortgages

The only real options for an interest only mortgage are repayment mortgage deals. However, you can still find payment-free interest plans with a mix of variable and fixed-rate deals too.

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