Could an interest only mortgage be right for you?

Posted on 9 September 2014 by Michelle Crowe

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Could an interest only mortgage be right for you?

An Interesting Proposition

Why an interest only mortgage might be right for you…

I have lost count of the number of times that a client has asked me if “interest only” mortgages are a thing of the past – and I always answer that no, they still exist, but only for very specific clients and only in very specific circumstances. Interest only mortgages have something of a tarnished reputation, following their widespread use prior to the recession when borrowers were relying on the value of their property increasing enough to clear the loan, rather than putting a repayment strategy into place and of course, some people found themselves with no way to repay their loan when this didn’t happen.

Interest only was one of the first areas of criteria that was tightened up following the financial crisis, and clients applying for an interest only loan were asked to prove they had a viable repayment strategy. Previously, lenders were prepared to accept the sale of the mortgaged property as a repayment strategy at any loan to value – this was reined in and many lenders applied a maximum loan to value on sale of property and over the last four years this has become tighter and tighter. Now, for those few lenders who still offer interest only with sale of the property as the repayment strategy, the maximum loan has to be set at 50% of the value of the house. Not only this, but often a lender will either apply a minimum income (usually £75,000 or above) or a minimum loan amount, which at present sits at £300,000. Therefore for most clients if they want an element of interest only without a formal repayment strategy then they will need to have a house valued at £600,000, and a loan of £300,000. Clearly this shows that many lenders only want to offer interest only to medium to high net worth clients, in areas where house prices are reasonably high.

So what else constitutes an acceptable repayment strategy?

Investments:

Traditionally investments have been used, and lenders will still consider these. But whereas in the past most banks and building societies would take a projection on an investment plan or endowment policy, increasing numbers are now just looking at the current value. This is fine if you are towards the end of your mortgage life and you have built up capital elsewhere – not so good if you are just starting out.

 

Pensions:

Some lenders will still consider pensions as a repayment strategy, but currently they will only consider 25% of the pension value. Some lenders will work off a projection for the final value of a pension, and then take 25% of that projected value; however there are a number who base it upon the value of the pension at the time of application.

Bonuses:

If a client has large bonuses then we may be able to place the case; you make the monthly interest only payments, and then once a year a lump sum goes in to reduce the mortgage. Usually, you need to have a track record of bonuses for the last three years, and confidence that they will continue because if you miss a lump sum payment your lender will switch you onto full repayment immediately.

Other properties:

Finally we can use sale of background properties; so if you have a buy to let portfolio or a holiday home then we can use the equity in that with some lenders.

Effectively lenders have removed the option for interest only unless you have enough equity in your home (or other houses) to cover the mortgage, or substantial assets to be able to repay the loan, both of which, I believe, are eminently sensible.

As a client if you want interest only there should be a good reason for it. If you want to protect your lifestyle by reducing your outgoings, but you can afford full capital repayment, as long as you have a repayment strategy that shouldn’t be a problem, if you can only afford the mortgage on interest only maybe you should consider borrowing less, as it may not be sustainable. Part of my job as a mortgage broker is to assess whether interest only is the best option for you, and to make sure that you have a viable and sensible plan to pay off what you owe. At John Charcol, we will look carefully at your individual circumstances and if interest only is suitable for you, we know which lenders generally consider this type of lending and have good relationships with them which can maximise your chances of being accepted.

If you’d like to talk to one of our advisers about this (or any other) type of mortgage, please give our team a call on 0844 346 3672.

The blog postings on this site solely reflect the personal views of the authors and do not necessarily represent the views, positions, strategies or opinions of John Charcol. All comments are made in good faith, and John Charcol will not accept liability for them.

This article does not constitute advice, and you should seek professional advice before applying for a mortgage.

Categories: Mortgage Lenders, Mortgages, Interest rates

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