Around three-quarters of homeowners with interest-only mortgages are worried they may not be able to repay their loan, according to new research.
What is an interest-only mortgage?
With an interest-only deal, a borrower pays just the interest on the loan during the life of the mortgage and then must repay the capital when the mortgage term ends. This can be done using a separate investment policy, such as an endowment or ISA. Worryingly, less than a third (31 per cent) of interest-only borrowers questioned by mortgage broker Ocean Finance said they have a separate investment policy in place to pay off the capital.
Some 16 per cent of borrowers said they plan to switch to a repayment mortgage - where you repay both the capital and the interest - before their current loan ends, while 31 per cent said they expect to have to sell their home to settle the outstanding capital. And a fifth of homeowners said they don’t have a plan in place to repay the capital.
Borrowers must take action sooner rather than later
Commenting on the results, Gareth Shilton from Ocean, says: “Interest-only has become a time-bomb because so many people took out the products to cut the cost of their mortgage, with no view of how they would repay the capital element. Borrowers who have an interest-only mortgage with no repayment plan need to take action."
Popular in the Nineties
Interest-only mortgages became popular in the 1990s as a way for consumers to afford homes at a time when property prices were soaring. Lenders often agreed interest-only loans without confirming borrowers could repay the capital owing at the end of the mortgage. By the end of 2012 most lenders stopped offering interest-only deals after tightening their lending rules.
Gareth adds: “While there is a place for interest-only mortgages, it's a specialised product that suits a small number of borrowers, rather than being the mass-market product it became in the 1990s. For example, if you have a large family home that you know you don’t plan to stay in once your children have left home, then interest-only could make sense."
Interest-only mortgages are now typically only being approved for borrowers who can demonstrate they have a repayment vehicle or pension pot that is forecast to repay the capital element. "Usually, borrowers also need to have a significant deposit that gives them a big equity gap," says Gareth.
If you want to stick to an interest-only mortgage, then you will need think carefully how you will repay the capital at the end of the term. You will need a repayment vehicle, such as a pension large enough to pay down the capital at the end of the mortgage term, or an ISA or other investment vehicle.
Another option is to make overpayments on your current mortgage. Most lenders will allow you to pay up to 10 per cent a year extra on an interest-only mortgage without a penalty.
If your mortgage is due to end in the next five years and you don’t have a plan, then speak to a mortgage adviser, for example, Charcol (0344 346 3708) or Ocean Finance (0161 672 7575), or your lender now so you can work out the best option. This problem won’t solve itself, so borrowers must take action sooner rather than later.
- For more money advice, check out the latest latest issue of Yours.