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Interest Only Mortgages  – are they a good idea

With Interest rates on the rise, badly affecting borrowers on fixed incomes or other tight budgets many homeowners are looking for ways to keep their mortgage outgoings down. Until recently borrowers could look to taking a fixed rate mortgage or remortgage which would fix their monthly repayment for the duration of the `fix`,  generally somewhere between two and five years.

The advantage of the fixed rate is that it gives the borrower certainty, knowing each month exactly what his repayment will be and allowing him to plan ahead, and relax knowing he won`t have to find any extra money for the period of the fix.

However with the Bank of England now raising rates on a regular basis and predictions of more to come, many lenders have withdrawn their fixed rate offers.

So what is the Homeowner with an already overstretched budget  and worried about the effect of future rate rises to do?

On option is to consider switching to an Interest Only mortgage.

With this type of mortgage, or remortgage, the borrower pays only interest on the full amount of his loan. There is no repayment element as with conventional repayment mortgages. The result is that the amount to repay each month is much less than it would be with repayment - sometimes as much as 50% lower.

The main drawback is that nothing is paid off the capital sum owed during the term of the interest only loan, and at the end of the term the borrower must find a way to repay the full amount outstanding.

One option adopted by many is to convert the mortgage to a repayment one after several years, perhaps when finances have improved or earnings risen. This is particularly attractive for younger people, stating out on their careers, such as First Time Buyers, who need to keep repayments low until their income has risen. Someone of say 30 will still have ample time to convert and repay.

It is important to bear in mind that the Lender will demand repayment in full at the end of the term, and this can present problems to individuals in older age groups or who cannot reasonably expect their earnings to increase so that a switch to repayment (with the usually higher monthly repayments) becomes possible. This is a particularly important factor to consider for those in older age groups, such as the over 50’s or those nearing retirement where the loan term will expire after they have retired. How will they continue to meet the interest payments in retirement, especially as their income may well fall? How will they repay the loan amount? Many people say they will `trade down` when asked this question but the ability to do so in any reasonable way will depend on the amount of equity left in the property. If for example  there was only £20000 equity, with the average property all over the UK costing over £100000 it will be impossible to find a property to move to.

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