With an interest-only mortgage your repayments only cover the interest on the amount you borrowed. Find out how to work out a repayment plan to pay off the capital at the end of the mortgage.
How does an interest-only mortgage work?
With repayment mortgages you pay off the interest and some of the capital each month, guaranteeing that the mortgage will be cleared at the end of the term.
With interest-only mortgages, you only pay off the interest on the amount you borrow.
You use savings, investments or other assets you have (known as ‘repayment vehicles’) to pay off the total amount borrowed at the end of your mortgage term.
If you have a £100,000 interest-only mortgage for 25 years, you’ll pay the interest on the amount you borrowed each month.
When the 25 years are up, you’ll have to pay the full £100,000.
Your repayment plan
You must be able to show the lender how you’ll repay the mortgage at the end of the term.
You - not the lender - are responsible for putting in place and maintaining a credible repayment plan to repay the original loan.
You can’t rely on the promise of a future windfall such as an inheritance or bonus.
You also can’t speculate that property prices will rise enough to allow you to buy a smaller home and still pay off the mortgage.
The lender will check at least once during your mortgage term that your repayment plan is on track to cover your mortgage.
Examples of repayment vehicles include:
Your lender will take a view about whether your chosen repayment vehicle looks likely to pay off the capital at the end of the mortgage.
Work out how much you need to save
You need to put in the mortgage amount and the length of time you have until it ends.
Then add in different rates of interest or growth you can expect on average over the term.
Pick a low and a high figure (2% – 5%) to see the worst and best result.
The value of investments can rise and fall and it’s possible that you could lose all of your money before you’re able to pay off your mortgage.
It’s important to review your investments regularly.
Ideally you’d want to be able to switch into much safer cash-based products as the term of your mortgage gets closer.
That way you’ll have the peace of mind that you’ve got enough to cover your mortgage. Speak to a financial adviser about the best investment plan for you.
Already have an interest-only mortgage?
If you have an interest-only mortgage, review your repayment plan regularly to make sure it’s on track. If you don’t have one in place, act now.
If you have more than 50% equity in your property and a repayment plan that’s on track and accepted by a range of lenders, then you should be okay.
If you don’t, you might find it difficult to remortgage when your existing deal comes to an end.
Review your repayment scheme
It’s essential you review your investment plan regularly and take action if you think it won’t provide sufficient funds to pay off your mortgage.
Talk to your lender or get professional financial advice.
- Contact your product provider, fund manager or financial adviser and ask if your investments are on track to repay your mortgage.
- Add up any separate savings beyond your repayment plan investments and see if you can release any of this money to reduce the loan if your lender will allow.
- Call your lender and ask about overpayments or switching to part repayment and part interest only. Check whether you’ll be charged any fees.
- If you’re worried that you won’t be able to repay the mortgage, contact your lender and explain the situation. If you can’t work out a solution with your lender, get free advice.
Since 26 April 2014, lenders have had to put repayment plans under greater scrutiny and conduct a full affordability assessment with evidence of income.
This means that people with interest-only mortgages taken out before 26 April 2014 might find it difficult to get another mortgage.
When granting new loans, lenders must assess whether or not you can afford to make the necessary payments.
This includes cases where you want to remortgage to another lender: your new lender will need to satisfy itself that you can afford the loan.
Your existing lender is allowed to offer you a new deal (i.e switch to another interest rate deal) as long as it does not involve increasing the amount you borrow (other than any fees for switching).
If you have an endowment policy
If you took out an endowment policy to pay off your capital and it looks like it won’t pay out enough to repay the mortgage at the end of the term, there are things you can do now.
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