Will Interest-Only Ever Be the Default Option for Homeowners Over Repayment?
Written on 19 January 2023 by
Cambridge recently broadened its interest-only mortgage rate. The Cambridge Building Society has introduced a 2 year interest-only discounted mortgage of 3.74% and a 5 year fixed rate of 5.34%. The Society already offers a 2 year fixed rate of 5.64%. There is no early repayment charge on the 2 year interest-only discounted mortgage.
Intermediary Manager Kathy Bowes, said:
"We have launched these additional products to broaden the range and provide greater flexibility to a wider range of applicants, in line with our strategy to provide appropriate access to homes and housing.
Mortgage affordability is assessed on an interest-only basis and our team of expert underwriters look at each application individually, which enables us to make sound lending decisions."
For clients that are considering interest-only or even part and part (mortgage split between part repayment and part interest-only) it’s important that you speak with a mortgage broker who can review your circumstances and establish which will be the most appropriate option as part of their advice.
What Are the Benefits of Interest-Only?
Smaller Monthly Payments
As you are only servicing the interest element of the loan and there are no monthly capital repayments, what you pay each month will be considerably lower. For example, if you borrow £250,000 on a 5 year fixed at an interest rate of 4.38% over a 25 year term, you’d pay £912.50 a month on an interest-only mortgage with NatWest compared to £1,368.88 a month on a repayment mortgage with Coventry at 4.35%.
As your monthly repayments are less this will mean any disposable income will be greater than if you had a repayment mortgage instead. With interest-only homeowners will have more control on where they spend their money - whether this be contributing towards investments, putting funds towards another property, ad hoc or regular overpayments on the mortgage, or something else.
Investment Portfolio Achieving More than the Amount Owed
There are certain repayment vehicles that the lender can typically consider when assessing you for interest-only: sale of property, unit trusts, endowment policies, stocks and share and investment bonds. For those that choose investment bonds as the repayment vehicle, you may be in the fortunate position that the funds are performing well, meaning you may have a more than you need by the end of the mortgage term. Nonetheless it’s important to consider the risk associated with this kind of repayment vehicle - for example in the event investment doesn’t perform against expectations, you will be expected to cover any shortfall when it comes time to repay the mortgage. As a rule, it’s smart to diversify your risk.
What Are the Considerations for Interest-Only?
More Expensive Overall
You’ll usually pay more interest overall than with a repayment mortgage because the amount you pay interest on doesn’t decrease during the term. This makes interest-only mortgages more expensive overall than repayment mortgages.
You’ll Still Owe the Full Amount at the End of the Term
You’re only paying off interest each month, so you’ll still owe full the full amount at the end of the term.
As a result, it’s important that homeowners regularly review the repayment vehicle and make changes/get advice if the repayment vehicle isn’t performing as well as expected while time is on your side.
As part of the Mortgage Market Review in 2014, MMR was very clear in making sure that when lenders and brokers are giving advice on interest-only mortgages, they check affordability thoroughly and ensure they evidence the plausibility of what the customer said they were doing. This is partially based on the hundreds of thousands of endowment policies mis-sold in the 1980s and 1990s. If you cannot afford to pay the lump sum at the end of your mortgage term, you may have to sell your home.
Advice to Homeowners Potentially Looking at Interest-Only Option for the First Time?
For any first-time buyers or homeowners who aren’t financially savvy I would typically recommend a client defaults to a repayment mortgage over interest-only as it is a more straightforward and cheaper way to borrow with a mortgage. Interest-only opens more risks as well as perceptions and attitudes can change over time – for example those that choose to use sale of property as the repayment vehicle could find that the equity in the property isn’t enough to find an alternative suitable property in the local area, resulting in relocating further from family and friends later on in life when you may not want to.
It’s important that you get the right advice from a broker that will review your circumstances and have a conversation about both the risk and benefits of interest-only to establish whether this is an appropriate option. Fortunately, our team can help. Contact us on 0330 433 2927 to find out whether interest-only could be right for you.
Category: Nick Mendes