Interest-only mortgages - what are they and should you switch to one
If you are struggling to keep up with your monthly home repayments, you might be wondering if you should switch to an interest-only mortgage.
In a nutshell, a mortgage can seem quite straightforward, you borrow the amount you need for a property and agree to pay it back in regular instalments.
The vast majority of households opt for a repayment loan, where you pay back the loan itself and the interest on top.
When you go interest-only, you only pay the interest that accrues on top of the loan rather than the loan itself - this means the amount you have borrowed stays the same.
Interest-only mortgages have faded in popularity since the financial crash in 2008 however with interest rates rising, one option floating around to help manage the costs is to switch to an interest-only mortgage.
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So what are the advantages and disadvantages of a interest-only mortgage? The Mirror asked a mortgage expert to explain.
Ultimately, if you are considering going interest-only, you should always speak to a mortgage broker first before making any big decisions.
What are the advantages of an interest-only mortgage?
Karen Noye, mortgage expert at Quilter noted that the "primary" advantage of a interest-only mortgage was "undoubtedly" the lower monthly payments during the term of the loan.
She explained: "You're required to pay only the interest charged by the lender, without having to chip away at the capital (money) you've borrowed.
"This can substantially lessen your monthly outgoings compared to a repayment mortgage, freeing up funds for other uses.
"In addition to these lower payments, there's the bonus of flexibility. You have the freedom to overpay, directing extra money towards the principal sum if your financial circumstances allow."
However, Karen said it was worth noting that some lenders might place restrictions or penalties on overpayments.
If you have an interest-only mortgage, Karen also explained that you could use the money you have saved from the lower payments for other investment opportunities.
She added: "If you can generate a higher return on these investments than the interest rate on your mortgage, you might find yourself in a financially advantageous position."
What are the disadvantages of an interest-only mortgage?
Karen said the most "glaring" issue with an interest-only mortgage was the "lack of equity in the building" as you're not paying off what you owe.
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So when you're term is up, you'll still need to repay the mortgage you took out.
She explained: "During the term of the mortgage, you're not paying off any of the capital you borrowed.
"This means you are not building up equity in the property unless its market value appreciates, so in the event of a housing market downturn, this might leave you in a precarious position where you owe more than your property is worth."
Karen also noted that the interest paid over the duration of the loan will be higher than on a repayment mortgage.
She said: "This is because you aren't reducing the principal sum during the interest-only term, which is the basis upon which the interest is calculated."
"A significant risk to consider is the potential 'payment shock' at the end of the interest-only term, once this period ends, your monthly repayments will rise dramatically as you'll start repaying the capital as well as the interest."
Karen said you would need to be prepared to handle this change or have a concrete plan to cover your remortgage payments to prevent financial hardship.
Interest-only mortgages are also "not as readily available as they once were" as since the financial crash in 2008 regulations were tightened, and lenders became more cautious.
They often required "significant deposits" or a more stringent proof of an approved repayment strategy.
Karen added: "If you are struggling due to soaring mortgage costs, interest-only could provide a solution for the short-term.
"As a long term option you need to ensure you have a viable repayment method in place as the mortgage loan will need repaying in full at the end of the term."
Should you switch to a interest-only mortgage if you are struggling?
Last month, the Bank of England upped its base interest rate to 5%.
This saw the average rate on both two and five-year fixed deals rise above 6% - and they are continuing to rise.
In response to the move, the Government worked to introduce a number of measures to help homeowners - this later came under the Mortage Charter which is a deal between the Government and lenders.
One of the measures was to allow households to make a switch to an interest only mortgage, but also go back to their original repayment plan within six months.
Adam French, senior editor at NerdWallet noted that the move would help give those struggling some "breathing space" whilst they sort out their finances.
He added: "This could be a simple case of budgeting and cutting some non-essential expenses, or it could mean selling up and finding a more affordable home.
However, he noted that the interest-only mortgage wasn't "without risk".
He explained: "If you can’t afford your normal monthly mortgage repayments at the end of the six months you will have to contact your lender to speak to it about your options.
"You may be offered other support options, such as extending the term of your mortgage, although it will mean you pay more in interest over the lifetime of your mortgage - ultimately it may mean having to sell your property.
“Homeowners can get into trouble with interest-only mortgages, particularly if house prices fall or rates continue to rise.
"For example, in the housing market crash of 2008, some homeowners found that once their interest-only periods ended, they owed more on their homes than they were worth, and couldn't afford the higher capital-and-interest payments."
For those considering switching, Adam said it was "essential" to weigh up the pros and cons beforehand even if it's for a short time.”
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