Ways of repaying an interest-only mortgage
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With an interest-only mortgage your repayments only cover the interest on the amount you borrowed and nothing off the original loan. You must put in place and maintain a suitable plan or strategy (referred to here simply as a repayment plan ) to pay off the capital at the end of the mortgage. Find out more below – including what to do if you’re worried you won’t have enough to repay an existing interest-only mortgage.
Interest-only mortgages – an example
If you have a £100,000 interest-only mortgage for 25 years, at the end of 25 years of interest-only payments you will need to have £100,000 to pay off the capital.
To find out how much you can afford to borrow use our Mortgage affordability calculator.
Types of repayment vehicle for an interest-only mortgage
You must be able to show the lender how you can repay the mortgage at the end of the term. You can’t rely on the promise of a future windfall such as an inheritance or bonus and you can’t speculate that property prices will rise enough to allow you to buy a smaller home and still pay off the mortgage.
It is you and not the lender who is responsible for putting in place and maintaining a credible repayment plan to repay the original loan. Even so, 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:
- cash saved in a savings account or ISA (although some lenders are no longer accepting this as a repayment vehicle)
- stocks and shares ISAs
- investment bonds
- unit trusts
- regular savings plans (endowment policies), and
- other properties or assets
You can find out more about how these work on our saving and investing pages.
Unless you understand how an investment works, it’s best to speak to a financial adviser.
How much do you need to save to pay the capital off?
To get an idea of the monthly amount you’ll need to put away in order to clear your mortgage at the end of the term use our simple savings calculator below.
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.
Important: 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.
New stricter criteria for interest-only mortgages
Interest-only mortgages are much riskier than repayment mortgages where 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, it’s the savings, investments or other assets you have which will pay off the sum borrowed at the end. Your lender will take a view as to whether these look likely to pay off the capital at the end of the mortgage.
As a result, many lenders have stopped offering them and others have introduced stricter lending criteria. For example some are asking for a 50% deposit (or 50% equity if remortgaging) and expect you to have a large salary. In all cases, lenders have to check that you have a credible strategy to repay the loan at the end of the term and, if this involves a savings.
Already have an interest-only mortgage? Why it’s important to review it now
Do something about it!
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 currently have an interest-only mortgage it is essential that you review your repayment plan as soon as possible – or put one in place if you don’t have one.
If you have more than 50% equity in your property and a repayment plan that is on track and accepted by a range of lenders, then you should be okay. But if you don’t, you may find it difficult to remortgage when your existing deal comes to an end.
It is 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.
Your options if you won’t have enough to repay your capital
Act now – the sooner you do, the sooner you can be confident that your mortgage will be repaid at the end of the term. Your options include:
- switching to a repayment mortgage with your current lender (this will mean an increase in your monthly payments)
- switching part of your mortgage to repayment and leaving part of it on interest-only
- paying more into an investment or saving plan, and
- using spare cash to reduce the mortgage
From 26 April 2014, lenders will have to put a repayment plan under greater scrutiny and have to conduct a full affordability assessment with evidence of income to demonstrate responsible lending. This may mean that some people with existing interest-only mortgages taken out before 26 April 2014 may find it difficult to get another mortgage.
When granting new loans, lenders are obliged to 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, however, 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).
Talk to your mortgage lender
If you’re in any doubt about paying off an interest-only mortgage, speak to your lender or a mortgage adviser about your options. Use the links below or search online.
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.