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What is an Interest Only Mortgage?

Interest only mortgages can be a great option when you’re looking to buy a home. Let’s find out why!

When you’re opting for which mortgage deal to go for, it’s not unusual to be overwhelmed with the choices at your disposal. One of these choices, interest only mortgages, can be a great option for loads of different buyers. Let’s find out why.

What is an interest only mortgage?

In essence, an interest only mortgage is where you pay the interest only for the mortgage term. Then, once your mortgage term has concluded you then pay the capital that you have borrowed from your lender. For example, you borrow £200,000 on an interest only payment basis over 25 years, all you pay each month for the next 25 years is the monthly interest on your £200,000. At the end of the 25 years you still owe your lender £200,000.

However, following the credit crunch in 2008, interest only mortgages have fallen in popularity. This is largely because vast numbers of people on interest only mortgages were struggling to pay off their home at the end of the mortgage term. Currently, most lenders who offer interest only mortgages now require a large deposit and a well-organised payment plan so that they are ensured the capital will be paid back at the end of the term. Let’s go into this a little further.

What will the repayment plan in an interest only mortgage involve?

To ensure that you can pay the capital back at the end of your mortgage term, your lender will want to review your repayment plan. While this will generally vary from lender to lender on what they deem as a sufficient repayment plan, there are definitely some hallmarks that most (if not all lenders) look for. Let’s see what they are!

An easy one you could look into is opening an ISA. If you open an ISA this will provide an easy means for your lender to conduct regular checks on your savings. This will help them to grasp whether you are on track to pay back the capital at the end of your mortgage term.

Alternatively, if you’re worried about being able to pay back the capital, then there are other options that you can consider. Investment bonds can often be a popular saving strategy for those with interest only mortgages. Investment bonds are basically a life insurance policy where you lend varying amounts of money to a party for a fixed term. Then, at the end of the term this amount will be paid back to you with interest. Therefore, as you can work out when you will receive your money back and the amount you will earn through interest, this can be seen as a fantastic contribution to your repayment plan. 

Worried about not being able to pay the capital back at the end? Here’s what you can do

First, you’re going to need to work out what you need to save. This can be done by getting the mortgage capital amount and the length of time that you have until the term finishes. Then, unless you have already been quoted an interest rate by a lender you should work out a few best and worst case scenarios. We recommend using percentages ranging from the 1.5% - 5% mark.

While we’ve mentioned how investment bonds can be a great means of contributing to your repayment plan, it’s going to be important for you to review your investments consistently. This is because investments can fluctuate and you do run some risk of not making as much money as you had planned to in your bond.

How should I review my repayment plan?

Reviewing your repayment plan is an essential part of making sure that the savings pot is going to plan & will have sufficient funds at the end of the term to clear your mortgage. It will also provide you with the opportunity to act if you spot anything that could be a problem or that the current plan you have in place won’t give you the funds to pay off the mortgage at the end of its term.

This can be done in a variety of ways. We recommend that you speak with your lender or an independent financial adviser as they can be a great tool for checking that your payments are on track. But as we all know, having a safety net even if everything seems like it’s going to plan isn’t a bad idea. This is why we think that you should find the sum of any savings that you have and how this money can be used to reduce the amount that you have borrowed.

If you’re at a loss still for how you can check your repayment scheme then you can also call your lender to ask about whether you can make any overpayments on your mortgage. This can be a sensitive subject for a lot of lenders. This is because if you overpay by too much and end up repaying the mortgage capital too early then they will lose out on interest. But be careful, this may mean you face an overpayment penalty. So, make sure that you check this over with your lender to see if it is a viable option. Alternatively, if you’re worried that you might not be able to repay your mortgage at all then contact your lender and explain your situation to them.

How we can help?

If you’re worried about your lender not giving you the advice that you need then, fear not! At Mortgages Online we can offer you impartial, mortgage advice that can help you make the most cost-efficient payment plan that works for you. So, check out some of the other articles on our site!

We’ve got loads of information on the different types of mortgages, home insurance, stamp duty and lifetime mortgages – and so much more. Visit our Articles section. All of this for free from Mortgages Online, no need for a credit card!

LauraWaller

Laura Waller

Laura Waller has been working in the mortgages industry since 2013, joining an independent brokerage in Essex. Laura has CeMAP 2 & 3 – Certificates in Mortgages Advice and Practice. Since then Laura oversees marketing for Mortgages Online, using her experience and expertise to write articles and blogs about mortgages and related topics.

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