Taking out an interest-only mortgage is one way to keep monthly repayments down, but you must keep in mind that you’ll need to repay the original amount you borrowed at the end of the term.
Steep living costs continue to put pressure on our household finances, and if homeowners with interest-only mortgages are forced to dip into their savings to cover costs, there’s a risk that they might not end up with enough to repay the capital they owe at the end of their mortgage term.
Research by the city regulator the Financial Conduct Authority (FCA) found that there are approximately 40,000 residential interest-only mortgages due to mature every year until 2032 where the consumer will be past 65 when the mortgage reaches the end of term. It is estimated that as many as half of all homeowners with interest-only mortgages may face a shortfall when it comes to repaying the capital they owe.
Here we explain what you can do if you have an interest-only mortgage and are worried about not being able to pay it off.
Want to speak to a mortgage advisor? Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage.
If you’re looking for expert mortgage advice, you can get a free consultation with an independent mortgage adviser at Fidelius. Speak with a qualified, FCA-regulated, independent mortgage adviser you can trust. Rated 4.7/5 on VouchedFor from over 1,250 reviews.
What are interest-only mortgages?
Interest-only mortgages, as the name suggests, are mortgages where you only pay back the interest you owe each month, and not any of the capital you borrowed. This must be repaid at the end of the mortgage term.
Interest-only mortgages were often aggressively sold in the 1980s and 1990s, usually alongside endowments (a type of investment plans with built-in life insurance) as well as in the run up to the financial crisis of 2009. The number of interest-only mortgage holders has reduced by 73% since 2012, and by the end of 2023, there were 664,000 pure interest-only mortgages, which is 5.4% fewer than in 2022.
Interest-only mortgages have become more popular in recent years as interest rates have risen, and many people have found their monthly mortgage payments have increased sharply. Some have therefore switched to an interest-only basis, or part repayment, part interest-only basis, so they can keep costs down.
How to apply for an interest-only mortgage
You apply for an interest-only mortgage in the same way you would any other type of mortgage – either by going directly to a lender, or via a mortgage broker.
When you apply, the lender will run a credit check on you to see if the mortgage is affordable, and they’ll also want to see proof of your income and outgoings, and will want to know how you plan to pay off the capital in future.
Want to speak to a mortgage advisor? Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage.
If you’re looking for expert mortgage advice, you can get a free consultation with an independent mortgage adviser at Fidelius. Speak with a qualified, FCA-regulated, independent mortgage adviser you can trust. Rated 4.7/5 on VouchedFor from over 1,250 reviews.
What are the benefits of an interest-only mortgage?
The main advantage of an interest-only mortgage is that because you’re only repaying the interest each month and none of the capital, your monthly payments are much lower than they would be compared to if you had a repayment mortgage.
This can help homeowners keep their outgoings to a minimum, although of course they do need to think about how they’ll repay the capital at the end of the mortgage term, which is where many people with this type of mortgage have come unstuck.
Who can get an interest-only mortgage?
Lenders have tightened up their eligibility requirements for interest-only mortgages in recent years, so you’ll often need quite a hefty income to qualify for one, or a substantial deposit to put down. They’ll also want to see a clear plan of how you intend to repay the mortgage capital.
Lenders won’t accept the promise of an inheritance or future windfall to pay off your interest-only mortgage, due to their unpredictable nature.
Those on lower incomes or who do not have a big deposit are therefore unlikely to be eligible for this type of mortgage.
What are the risks of an interest-only mortgage?
The issue is that around half of people who have an interest-only mortgage may not be able to pay it off in full, and may also not be able to switch to a standard repayment mortgage if they don’t meet the strict affordability criteria that lenders now have in place.
If you find yourself with an interest-only mortgage that you think you’re going to be unable to pay off, it’s important to be aware of the options that could help. Find out more in our guide What can you do if you can’t pay your mortgage?
How can I pay off my interest-only mortgage?
There are several options available to homeowners looking to pay off interest-only mortgages. For example, you might be able to:
- Switch to a retirement interest-only (RIO) mortgage. Depending on your circumstances, you may be able to remortgage to a retirement interest-only mortgage, where you carry on paying interest each month but the capital only has to be repaid when the property is sold after you move into long-term care, or after you die, with the remaining value of the property forming part of your estate. Learn more about this option in our article How retirement interest-only mortgages work.
- Switch your entire mortgage to a repayment mortgage. With a repayment mortgage, your monthly payments not only cover the interest but also part of the mortgage balance, meaning that you repay the total amount at the end of your agreed term. This will give you peace of mind that your debt will be fully paid off at the end of your mortgage term, but it may not be an affordable option for many.
If you can meet the lender’s affordability assessment, it’s usually fairly straightforward to switch your mortgage from an interest-only to a repayment basis.
Want to speak to a mortgage advisor? Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage.
If you’re looking for expert mortgage advice, you can get a free consultation with an independent mortgage adviser at Fidelius. Speak with a qualified, FCA-regulated, independent mortgage adviser you can trust. Rated 4.7/5 on VouchedFor from over 1,250 reviews.
- Make overpayments. Many mortgage lenders will allow you to overpay up to 10% of your mortgage balance each year without penalty, so if you have savings available, you may want to use some of them to pay back your mortgage capital.
- Switch your interest-only mortgage to a part repayment and part interest-only mortgage. Also known as a part and part mortgage, this is a combined solution where instead of repaying your full loan plus interest over an agreed time, you only pay the interest plus an agreed proportion of your mortgage each month. You could take out a repayment mortgage for the ‘shortfall’ element and keep the remainder on an interest-only mortgage.
- Consider equity release. If you find yourself unable to pay off your interest-only mortgage but without a plan to fall back on, then equity release could be an option for you. Equity release is a way of unlocking some wealth from within your property and can be used to provide you with a lump sum to pay off your interest-only mortgage without having to sell your home. It’s not without significant risks however, so it’s vital to seek professional financial advice first, as there are plenty of pros and cons to consider, and it definitely won’t be the right option for everyone. If you’d like to find out more about equity release, you might like to read our article: Equity release – what is it and how does it work?
Want to speak to a mortgage advisor? Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage.
If you’re looking for expert mortgage advice, you can get a free consultation with an independent mortgage adviser at Fidelius. Speak with a qualified, FCA-regulated, independent mortgage adviser you can trust. Rated 4.7/5 on VouchedFor from over 1,250 reviews.
- Downsize your home. If you’d prefer not to release equity from your home and have no savings or investments available, you may decide to sell your property to pay off your interest-only mortgage. However, you’ll need to think carefully about what kind of property you’ll be able to afford next, and what sort of location is right for you. Read our article Five questions to ask yourself if you’re considering downsizing to find out more.
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