What is an interest-only mortgage and how does it work?
If you have an interest-only type of mortgage, the loan amount that you borrowed remains the same and is expected to be repaid at the end of the mortgage term. Interest-only mortgage payments pay off the interest that is charged on your mortgage each month but not the capital that you borrowed so the balance of your mortgage will not reduce. This is in contrast to a repayment mortgage where your monthly mortgage payments are made up of the interest that accrues as well as some of the capital that you borrowed so that eventually, your mortgage is repaid by the time you reach the end of your mortgage term.
Mortgage lenders usually require interest-only mortgage customers to put a 'repayment plan' in place to pay off the full mortgage loan amount at the end of the mortgage term. The mortgage term will be decided at the outset and is usually between 20 years and 25 years. Although your mortgage lender may check that your repayment plan is in place at the outset, it won't usually check that the plan is on track to reach its goal by the time you come around to repaying the mortgage balance. Therefore, it is extremely important that you review this from time to time to ensure that you will be in a position to repay the mortgage when it ends.
What happens when my interest-only mortgage ends?
Once your interest-only mortgage ends, you will stop paying your monthly payments and you will be required to pay off the mortgage loan. In an ideal situation, you would use the money derived from your investments, savings or the sale of your home to pay your mortgage lender.
Ways to repay your interest-only mortgage
There are a number of ways you can repay your interest-only mortgage once it ends and these include:
- Investments - putting money into investments that can grow over the period of your mortgage meansing you can use them to repay your mortgage balance at the end. Be mindful that your investments may not grow as predicted leaving you with a shortfall.
- Savings - money in savings can earn interest helping you to build enough funds to repay your mortgage.
- Pension - it can be possible to use a tax-free cash lump sum from your pension to repay your mortgage as long as your mortgage term ends when you retire and there is enough money in your pension fund to do so.
- Down-sizing - you may be happy to move into a smaller or cheaper home at the end of your mortgage as children grow up and move out. You should monitor house prices where you want to live to ensure you have enough money left over after repaying your mortgage.
What if I can’t repay my interest-only mortgage?
There are a number of reasons why you may find yourself unable to repay your interest-only mortgage. Despite the fact your lender will have required you to put a plan in place at the outset of your mortgage, things can and do change so your outcomes may not be the same as you had imagined them. Below we describe options that you should consider and explore if you find yourself unable to repay your interest-only mortgage.
Regardless of the reason why you cannot repay your interest-only mortgage, it is key that you address this as soon as you realise so as to maximise the solutions that may be available to you. Speak to a specialist mortgage broker* to explore all of your options.
Can I extend my interest-only mortgage term?
Yes, it is possible to extend your mortgage term on an interest-only mortgage but this is dependent on your lender. In most cases, your mortgage lender will use discretion to consider applications for an extended term and will need to be assured that you are able to afford the repayments over the extra years you request. It is also very likely that your mortgage lender suggests that you switch some or all of your mortgage loan to a repayment type of mortgage so that you are repaying it as you go along. Repayment mortgage payments will be higher than an interest-only payment so you will need to show that you are able to afford these.
Borrowers who reach retirement age during the extended term of their mortgage will have to consider whether any change to their income will impact their ability to keep up with the new mortgage payments. Hence why it is difficult to get an extension to your mortgage term as you get older and closer to retirement age.
Can I change my interest-only mortgage to repayment?
Yes, it can be possible to switch your interest-only mortgage over to a repayment mortgage, either fully or partially and this is usually the solution your mortgage lender will prefer. Again, you can only switch your mortgage to a repayment type of mortgage if you are able to afford this based on your income and if your mortgage lender allows it. You may have to show evidence of earnings to successfully switch your mortgage type.
It is worth remembering that even if your mortgage lender is unable to switch your mortgage to a full or part repayment mortgage, other lenders may do so and there are a number of specialist mortgage lenders that can help so you should speak with a specialist mortgage broker* to search for mortgage solutions across the market.
Can I overpay an interest-only mortgage?
You may be able to make overpayments to reduce your interest-only mortgage balance and these can usually be made by increasing your regular monthly mortgage payments or by making lump sum payments. The overpayments could reduce the balance of your mortgage which could in turn mean that your interest-only mortgage payment is reduced as this is a percentage of your mortgage balance. However, you must check the terms of your mortgage for early repayment charges which may be applied by your lender. Often lenders limit the amount that you can overpay your mortgage by each year and if you exceed this amount, a penalty is charged that could negate any positive impact of overpaying.
Most mortgage lenders require that your mortgage term ends by your 75th birthday at the latest if you have a standard mortgage. Specialist mortgage products can run beyond this age and we describe these below.
Alternative ways to repay your interest-only mortgage
Later life lending
There are some specialist mortgage solutions for people who need a mortgage to continue into later life, be that because they are unable to repay an interest-only mortgage or otherwise. These types of mortgage solutions are usually classed as 'later-life lending' and can include an equity release mortgage called a Lifetime mortgage and Retirement interest-only mortgages.
Equity-release
An equity release mortgage is one that allows you to access the value within your home without having to sell the property. This option can provide you with the funds to repay your interest-only mortgage as long you meet the criteria to qualify. There are two types of equity release mortgages - a home reversion plan and a lifetime mortgage.
Home reversion plan
A home reversion plan can allow you to release some equity from your home that could be used to repay your interest-only mortgage. Taking a home reversion plan means that you choose to give up a certain percentage of the equity in your home in return for a usually, much smaller percentage of the value of your home that you take as equity release. This equity release mortgage product can provide little value for money but may be one that suits the parameters of what you need and are able to qualify for.
Lifetime mortgage
A lifetime mortgage allows you to release equity from your home to repay your interest-only mortgage. You do not repay this amount, nor do you pay any interest on the amount that you release, so there are no monthly repayments with this option.
However, the amount of money that you release and the interest that accrues over the period of your life is repaid to the lender either when you die or move into permanent full-time care. For joint applications, the equity release loan would need to be repaid once the second of the applicants either died or was moved into permanent care. Usually, this is done by selling the house and using the proceeds to repay the equity release loan but your family can choose to repay it from other funds if they wish to keep the home.
Lifetime mortgages can offer a 'no-negative equity' rule so that regardless of changes in the house market, the loan will always be covered by the sale price of your house so you needn't worry about house prices falling below the level needed to repay the loan.
Lifetime mortgages are usually available if you are 55 years or older and the amount of equity you can release is usually between 25% and 60% of the value of your home based on your age. However, the qualifying criteria can vary between lenders so you should speak with a mortgage specialist.
Not all mortgage brokers are able to provide advice on equity release mortgages and you cannot arrange one without advice from a regulated adviser. You can source an equity release specialist using VouchedFor*, a service that allows you to find vetted financial professionals in your area.
You can read in detail about Lifetime mortgages in our article, "What is equity release and how does it work? – Equity release mortgages explained".
Retirement interest-only mortgage
A retirement interest-only mortgage is simply an interest-only mortgage that is offered to people in later life. Namely, there is no end date to a retirement interest-only mortgage so it can continue until you die or permanently move into care. You do, however, have to pay the interest on your mortgage each month unlike with a Lifetime mortgage but the positive impact of this is that the interest does not accrue to be paid after your death or move into a long-term care home.
Due to the fact that you must make regular monthly interest payments against this type of mortgage, your affordability will be checked and the amount of money you can borrow is subject to income multiple limits.
Retirement interest-only mortgages are usually available to those over the age of 50 and may offer a smaller percentage of your home value compared with a lifetime mortgage so it is advantageous to compare all of your options before making a decision.
You can read more about retirement interest-only mortgages in our article, "What is a retirement interest-only mortgage and should I get one?".
You may also find a small number of mortgage products under the later life options that allow you to arrange a repayment mortgage that could potentially run until you are 95 and be repaid through the sale of your house if you were to die before this. The obvious advantage of this type of solution is that you will be able to reduce the amount of the mortgage loan, thus leaving a more valuable asset for your beneficiaries once you die. However, the affordability criteria for a repayment mortgage will require a larger income as the mortgage payments will be higher than what you would expect to pay for an interest-only mortgage.
Summary
Interest-only mortgages can be more affordable at the outset but without a full-proof plan in place, repaying the balance at the end of your mortgage term can become a problem.
However, due to the increasing number of mortgage borrowers who find themselves in this situation and the increasing age of first-time buyers, there are a number of solutions available to help people navigate this situation. The key to achieving a good outcome is to act fast and talk to your lender or mortgage broker so that you can explore your options, understand which solutions are available to you and take action so that your credit score is not impacted.
You can find mortgage specialists in your area using the VouchedFor* service which allows you to search professionals in your area based on real customer reviews. They will discuss your circumstances, explain which options you can take advantage of and support you through the application process.
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