Data from UK Finance shows that in 2019 there were 1,023,000 interest-only mortgage loans outstanding, equating to a value of £172bn.
Tragically, 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 the problem is and what you can do if you’re one of them.
What are interest-only mortgages?
Interest-only mortgages 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. There are several ways that an interest-only mortgage can be paid off:
- When the property is sold
- Using savings or investments, such as stocks and shares ISAs, or an endowment. However, there’s no guarantee that investments will produce the amount you need to pay off your mortgage in full, as their value can fall as well as rise
- Using some of the proceeds from your pension.
Due to their unpredictable nature, you can’t rely on the promise of an inheritance or future windfall to pay off your interest-only mortgage.
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 58% since 2012, but some people never took out an investment plan to pay theirs off and many endowments won’t make anything like the amount that was promised.
What’s the problem with interest-only mortgages?
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 in the wake of the financial crisis.
The city regulator the Financial Conduct Authority (FCA) has stated that more than 40,000 interest-only mortgages are expected to mature every single year until 2032. They have highlighted three peak periods of interest-only mortgage maturity. The first peak was 2017/2018, the second will be in 2027/2028, and the last will be in 2032 (driven by interest-only mortgages opened between 2005 and 2008).
Last year, the FCA announced new measures for those who were set to repay their loan before 2020. The measures were introduced on 23 October 2020 in response to the impact of coronavirus and included guidance that firms should allow borrowers to delay repayment on mature interest-only mortgages until 21 October 2021 (provided borrowers are up-to-date with their payments). If you’d like to find out more about these measures, you can visit the Financial Conduct Authority website here.
Eric Leenders, managing director of personal finance at UK Finance, said: “Like many homeowners at this time, interest-only customers are managing through the hugely uncertain impact of Covid-19 and the industry has a plan to help, so we would recommend that customers contact their lender if they are worried about their finances to discuss the support available to them.”
If you find yourself with an interest-only mortgage that you don’t think you’re going to be able to pay off, it’s important to be aware of the options that could help.
How can I pay off my interest-only mortgage?
If you have an interest-only mortgage and you don’t think you’re going to be able to pay it off at the end of the mortgage term, you may have several options. 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.
There are a number of fee free RIO mortgage brokers available in the market, but if you are looking for somewhere to start, we’ve partnered with Tembo Money. They can provide you with a free consultation and research the various options on your behalf to help you decide whether a RIO mortgage might be right for you.
- 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 lenders affordability assessment, it’s usually fairly straightforward to switch your mortgage from an interest-only to a repayment basis. If you want to speak to a mortgage adviser about your circumstances and the options available to you, we have partnered with Fluent Mortgages to offer high quality, fee free mortgage advice to our members. You can contact them here.
- 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 so 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 won’t be right 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?
If you’d like to speak to someone about equity release, we have partnered with Key Advice Group, a member of the Equity Release Council who have an excellent customer service rating on Trustpilot. If you are interested in a free, no obligation conversation with one of their equity release specialists to see what type of equity release product might be suitable for you, you can call 0800 188 4813 or request a free call back here.
- Sell your house. 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.
We hope you’ve found this guide useful. If you currently have an interest-only mortgage and would like to share your experience you can join the money discussion on the Rest Less community forum or leave a comment below.