HOMEOWNERS can pay back their mortgages through an interest only option – here’s everything you need to know if you’ve never heard of one.
The vast majority of households opt for a repayment loan, where you pay back the loan itself and the interest on top.
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But you can opt for an interest only mortgage where you only pay back the interest and none of the capital.
Of course, there are advantages and disadvantages to taking this option, including having to potentially pay out more money in the long term.
It comes after the Government announced all homeowners can change their mortgages to interest only.
Chancellor Jeremy Hunt stepped in after rates soared following the Bank of England hiking its base rate to 5% in June.
The BoE took the measure in order to bring down stubbornly high inflation, which stood at 8.7% in May.
But it saw the average rate on a two-year fixed deal rise to 6.01% while a typical five-year fixed deal went up to 5.67%.
The Government’s response was to introduce a number of measures to help homeowners.
Households can now make a switch to an interest only mortgage, but also go back to their original repayment plan within six months.
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The option is available without the need for affordability checks, nor will it impact homeowners’ credit scores.
If you’re thinking about taking the interest only mortgage route, here’s everything you need to know about them.
What is an interest only mortgage?
When deciding how to repay the mortgage back on your home you have two options.
You can opt for a repayment option – this involves paying back a small part of the loan you took out and interest on top each month.
If you meet all your payments, it means you will be guaranteed to pay off the entire loan by the end of your agreed term.
Or, you can opt for an interest only loan, where you only pay back the interest on the loan every month.
For example, if you have a £100,000 interest only mortgage on a 25-year term, you’ll only pay the interest you borrowed each month.
Therefore, when the 25 years are up you’ll have to repay the full £100,000.
As another example, lets say you’ve borrowed £200,000 on an interest only basis on a 25-year term at an interest rate of 3%.
Your monthly repayments would be £500 a month.
But, you’d still owe the lender the £200,000 cost of the original loan after the end of the 25-year term.
Interest only lending soared prior to the 2008 financial crisis, with customers able to borrow without showing lenders how the debt would be repaid.
After the crash, it turned out hundreds of thousands of interest only customers would struggle to pay their home loan off later on down the line.
Since then, it has been typically difficult to borrow on an interest only basis, until the Government’s announcement in June.
What are the advantages and disadvantages?
One of the main and obvious advantages of an interest only mortgage is that your monthly repayments are lower.
Plus, it means you can use any extra cash you’ve saved to add the value of your property, by carrying out renovations for example.
But, one major disadvantage is that it can be more expensive overall to go for this option.
This is because you are not paying off any of the actual loan you took out with your lender.
Plus, you might end up in situation where you can’t afford to pay off the debt later on down the line.
Consumer expert Martyn James said: “The obvious problem here is you will not end up owning the property unless you have an alternative way of paying off the debt.
“A lender will usually want to know how you intend to do this too.”
But, he added: “If this is a temporary option, then the lender may allow you to switch to an interest only deal temporarily.”
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