An interest-only mortgage can sometimes be limited to buy-to-let investment properties, particularly by landlords.
An interest-only mortgage can sometimes be limited to buy-to-let investment properties, particularly by landlords. However, interest-only mortgages are also available for residential purchases to UK residents.
An interest-only mortgage is a repayment strategy where:
Only the interest charges are paid each month on the amount you borrowed.
You payback the original amount you borrowed from the lender at the end of the interest-only mortgage term
Taking out a mortgage on an interest only basis means:
This means you will need a way of paying back the remaining balance. This will be the total borrowed amount at the end of the term of repaying interest only.
A repayment mortgage is also known as a capital repayment mortgage, which is the most common form of repayment plan.
Taking out a capital repayment mortgage means:
Your monthly repayments will consist of both:
(i) A small amount of the actual loan.
(ii) An amount of interest.
The original loan amount owed will reduce every month - as long as you keep up the repayments. The interest rate on a repayment mortgage can either be a fixed rate or variable rate. A variable rate means the interest rate can go up or down.
Different mortgage lenders may offer their own type of interest-only mortgages.
Your eligibility will take into account your personal circumstances, together with a lender's assessment, based upon:
You must be able to clearly prove that your income provides enough money to fully meet the lender’s minimum threshold for one of the mortgage types agreed. Your ability to meet the obligation, and not fall short each month, will depend on presenting an acceptable repayment plan.
Lenders can often be reluctant to offer an interest-only mortgage, of any type, if it's for the purchase of a non-standard construction property.
Their concern is usually based upon type of construction materials used and /or a non-standard design, leading to:
Higher than normal maintenance and repair costs.
Likelihood of a shorter lifespan.
Potentially greater risk to fire, damp or structural problems.
Concern over ability to resell when a home may be repossessed for monthly payment defaults.
Mortgage lenders usually set a minimum and maximum age for borrowing.
A number of interest-only mortgage providers may have no maximum age limit. Others also offer specific, age-related mortgage products, such as retirement interest-only (RIO).
Investment properties are often purchased by landlords who will also seek buy-to-let mortgages.
If you are a landlord typically seeking an interest-only mortgage for the purchase of a HMO (house of multiple occupancy), you will need to show the lender proof of previous landlord experience.
First-time landlords may be considered by an interest-only mortgage lender who is likely to be a specialist mortgage provider.
A history of credit issues may be considered a real obstacle to obtaining an interest-only mortgage. if you have have or had credit issues, we advise you to seek specialist advice to obtain the right mortgage for your financial situation.
It's essential that you have an acceptable repayment plan in place which is clear, defined and workable.
Your ability to keep up repayments for the entire mortgage term is the single most important factor.
Fortunately, there are a number of options for how repayments on your mortgage can be made. Advice should always be sought from an independent financial advisor or specialist broker, regulated by the Financial Conduct Authority (FCA).
Financial advisors, mortgage brokers and lenders may recommend interest-only deals to borrowers with a secure repayment plan for the original loan amount and significant equity.
The deposit amount for an interest-only mortgage can be greater than for a repayment mortgage. This is because the 'loan to value' (LTV) of an amount offered on interest-only mortgages is usually lower than for capital repayment mortgages.
Each lender will make their own evaluation which can vary from one another. A typical deposit can be:
25 per cent - buy-to-let properties.
Up to 50 per cent - residential properties.
Directly with a mortgage lender.
Through a mortgage broker.
Property buyers often have the best chance of securing the most affordable interest-only mortgage if they apply through an established mortgage broker.
It's always recommended to seek advice from a mortgage broker, who will act as your independent advisor.
Intended use of mortgage can affect the amount you can borrow
The amount you borrow on an interest-only mortgage loan will also depend on the purpose of the mortgage.
Buy-to-let/ investment properties - the amount of monthly / yearly rental income the property is expected to yield.
Residential properties - usually based on an affordability calculation, unique to each lender. It should be noted that a lender is likely to offer a loan-to-value (LTV) which is lower compared to a residential repayment mortgage based upon the same income level.
Your repayment plan is key to whether you're accepted for an interest-only mortgage amongst other factors. Some lenders will accept a number of different plans to pay off the original loan amount.
You will also need to supply firm evidence of your proposal, which may include:
Typically, a popular choice for those who purchased an investment property. Can also be an option when 'downsizing' to a smaller and lower value property.
Acceptable repayment options also include investing in an ISA (Individual Savings Account), stocks and shares, bonds or unit trusts.
A further method to repay the loan is the use of personal savings, if sufficient to cover the original amount, or inheritance money. A further type of 'cash payment' may be in the form of the 25 per cent tax-free lump sum, which can be "drawn down" from your pension pot. You may also be able to make regular lump sum payments against the original loan amount - as well as the monthly payments of the loan's interest - throughout the mortgage term.
The decision to remortgage will take into account key factors such as your age and the maximum lending term agreed. You may decide to do this as you reach the end of your mortgage term. Alternatively, and depending on your present position, your mortgage could be extended by a current provider.
Overpaying your mortgage
Mortgage overpayments are a commonly-used strategy. Rather than pay just the interest on the loan each month. Subject to your agreement terms, up to 10 per cent each year may be allowed by your lender to exceed the agreed repayments on your mortgage, and the outstanding amount of the original loan. However, a penalty may be imposed for an early repayment outside of the lenders terms.
What are Early repayment charges (ERC)?
Your lender may impose a penalty, known as an early repayment charge (ERC) if you:
Overpay by more than the amount agreed between you and the lender.
Pay off the entire loan earlier than the agreed mortgage term.
The amount of the ERC imposed is normally a percentage of the outstanding mortgage. This can be typically between 1 - 5 per cent but is always disclosed on your mortgage illustration.
I can't repay my interest-only mortgage loan - what happens next?
It's important to understand what will happen if you can’t repay an interest-only mortgage. Under the agreed terms and conditions, the provider has a legal right to take repossession of your home if the loan has not been repaid by the end of the mortgage term.
If you're considering an interest-only loan you need to know there could also be financial risks involved, such as:
Interest rates rising - If your Interest-only mortgage has a variable interest rate, this means that any increase in interest rates will see the amount of interest you pay on your mortgage also rise.
Temporary low repayments - If you have a fixed rate mortgage, once the period of low monthly repayments on your interest-only loan are complete you may see a noticeable increase in your payments on the original loan amount.
Equity loss - The value of the property you are buying may not increase in value and your loan to value remains static or in a worst case scenario the value decreases.