In his latest feature for What Mortgage, Greg Cunnington, director of lender relationships and new homes at Alexander Hall, talks to us about interest-only mortgage options and how an intermediary can help you decide if they are suitable for your circumstances.
The number of interest-only mortgages available to people who want to buy a home to live in has nearly doubled in the past six years, according to new research from finance data provider Moneyfacts.
In May 2013, there were 102 ‘residential’ interest-only mortgages available. By May 2019, this had risen to 193.
Despite the increase in the number of interest-only mortgages available, it is still a topic not readily understood. Many clients are unsure whether an interest-only mortgage is suitable for them or not. Here we aim to explain what an interest-only mortgage is and how an intermediary can offer advice to help.
What is an interest only mortgage?
Borrowers who take out an interest-only mortgage pay only the interest charged each month for the term of the mortgage. They then need to have a clear plan to repay the amount borrowed by the end of the mortgage term.
This differs from a more traditional capital repayment mortgage. With a capital repayment mortgage, you pay back a small part of the loan plus the interest each month. Assuming you make all your payments, you’re guaranteed to pay off the whole loan at the end of the term.
This means that with an interest-only mortgage the monthly payments are a lot cheaper, but you are not repaying your debt. You will also pay more interest overall during the mortgage term.
What repayment vehicles do lenders accept for interest only mortgages?
Before the financial crisis of 2008 interest-only lending was available without documented evidence required on what a client’s plan was to repay the borrowing at the end of the term.
This caused concerns that some borrowers with an interest-only mortgage may struggle to repay the borrowing at the end of the term, and so lenders now have stricter criteria in place for interest-only mortgages. They will also require documented evidence of your intended repayment vehicle.
A good intermediary will be able to fully assess your individual circumstances and see if you would be eligible for an interest-only mortgage, based on your income, equity, assets and future plans.
Below are some of the most popular repayment vehicles that lenders look for:
Sale of the mortgaged property
Some clients with sufficient equity aim to sell the property before the end of the term and to downsize with a cash purchase using the equity remaining in the property. This is acceptable to some lenders, but typically they will have minimum income and minimum equity requirements.
The lender will also ask about your future purchase plans so they can sense check that the purchase plans would be feasible with the equity figure. These will often be capped at 50% loan-to-value (LTV), meaning a client requires a 50% deposit.
However, some lenders will allow a ‘part and part’ mortgage (part interest-only, part repayment) where a smaller deposit is put down and the remaining mortgage amount can be on a capital repayment basis. These will still typically require a 25% deposit.
Sale of other properties owned
You may have other properties that you intend to sell within the mortgage term to repay your main residence mortgage, but do not want to sell currently. This could be because one is a home used for work purposes, you may have a second home that your parents reside in, or you may have buy-to-let investment properties that you do not wish to sell for a few years yet.
This is acceptable to some lenders, but their criteria and the documentation they require to evidence this can vary drastically. A good intermediary will be able to guide you through this.
Some lenders will allow cash overpayments as a suitable repayment vehicle. This can take one of two forms.
The first involves some cash being held back that can be evidenced to cover the interest-only borrowing amount in savings. The second is where some lenders will use surplus income from an affordability calculation, with the client stating a preference to repay with more flexibility than a repayment mortgage.
You may have assets that you wish to use to repay an interest-only mortgage. Common assets which can be used for this purpose include pension funds, ISAs and endowments.
Lenders will require documentation to evidence the sums held in the assets are sufficient. A good intermediary can help you with the paperwork requirements here.
What are retirement interest only mortgages?
Of the 193 residential mortgages that have ‘interest-only’ as the only repayment option, 43 are retirement interest-only mortgages( RIOs).
RIOs are a relatively new option in the later life borrowing space. They are designed for those aged 55 or above, and offer a good option for clients who are potentially coming to the end of their current mortgage term but are unable to pay off the balance and do not want to sell the property.
A retirement interest-only mortgage is designed to enable you to use your home as way to repay the mortgage balance in the event of death, a move into long-term care or selling to purchase a cheaper property, if you have enough equity. As such, these do not have a set mortgage term and this also means the affordability assessments are not as strict.
Because they have a set monthly interest payment, unlike some equity release mortgages, the interest does not roll up onto the mortgage balance.
When looking at later life borrowing options you should always ensure you speak to an adviser who will help look into all options for you. More information can be found at the later life borrowing section of our website, https://www.alexanderhall.co.uk/later-life-borrowing/
Is an interest-only mortgage right for me?
Although certainly not for everybody, for some customers an interest-only mortgage can be a very attractive option. If you have a robust repayment strategy in place and you understand the commitment you are making with this type of mortgage, the flexibility on how and when you repay the mortgage is a real plus and can fit in with a wide variety of client circumstances.
Below are a few examples of recent client scenarios we have seen. These clients had alternative repayment strategies in place and wanted the flexibility of the lower monthly payments and to overpay throughout the mortgage term:
◾Family with large school fee commitments that end in five years’ time; also set to shortly receive an inheritance lump sum (in probate) that they want to put into paying down their mortgage
◾Limited company directors who pay themselves the majority of their income as an annual dividend
◾Client who receives a large annual bonus
◾Client on commission with a low basic salary but a high overall income. The lower monthly payments created less pressure if the commission income was low in some months
◾Family with two background properties, one where a dependent relative resides and one a buy to let. Plan to sell both of these to repay the main residence mortgage
◾69 year-old clients with a mortgage term expiring with no savings to repay. Wished to sell and downsize, but not for another ten years
In reality most clients looking at an interest-only mortgage will have more than one repayment method. This typically combines over payments and then the sale of assets or property.
It is vital that you receive expert advice and have a thorough overview taken of your circumstances to see if an interest-only option could be suitable. A good intermediary will be able to do this for you, as well as ensuring you have a full understanding of what an interest-only mortgage is and the options that exist for you.
Let’s take a look at a recent case study of clients of ours who took out an interest only mortgage.
A married couple, Michael and Faye (names changed), live in a house in south east London. They have had a second child recently and need more floor space, so want to upgrade to a larger property.
They have a strong joint income, and so are comfortable with taking a much higher mortgage amount on the new purchase. However, they have school fees for one of their children and childcare costs for the other, so keeping initial monthly payments as low as possible is very important to them. They also both receive commission income that has allowed them to make lump sum over payments into their residential mortgage in the past.
We approach a bank that takes a holistic view of the circumstances. The clients want their repayment strategy to be the future sale of the property and a cash downsize, with the flexibility to overpay using their commission income and the possible sale of a buy-to-let property within the mortgage term to pay down the interest-only element.
The clients have a 25% deposit so the bank is flexible to set up the majority of the loan on an interest-only basis to a maximum of 50% of the purchase price, and the remainder to be on a capital repayment basis. The monthly payments are comfortably within the client’s budget, and are still lower than the mortgage payments on their current main residence, so they are delighted with this option.
Property value: 900k
Loan amount: £675k (£450k interest only)
Rate: 1.67% 2 year fixed rate
Term: 25 years
Lender arrangement fee: £999
Mortgage payment: £1545
THINK CAREFULLY BEFORE SECURING OTHER DEBTS AGAINST YOUR HOME.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE OR ANY OTHER DEBT SECURED ON ITThis article was originally posted in What Mortgage online. You can see the original article here. Please note this will launch a new web page.