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Interest Only Loans

You may have given thought to taking out an interest-only mortgage and attempted to weigh up the benefits against the flaws; we approached the subject in a similar way and made some interesting finds. Industry figures have revealed a rise in the number of homebuyers choosing interest-only loans, these following years of declining interest.

Figures from the Council of Mortgage Lenders (CML) show that the number of interest-only first-time-buyer mortgages has crept up by 5 per cent over the last two years. This trend comes largely from borrowers who are attempting to cut costs by switching to interest-only in the hope that house price will in the future rise and thus rescue them from their mortgage debt. As the name interest-only implies, borrowers pay only the interest on their loan each month. Their repayments make no inroads into the original loan, which must be repaid somehow at the end of the mortgage term.

The monthly savings made by choosing to take out an interest-only can be substantial. A typical 25-year £100,000 interest-only mortgage at 5 per cent costs £416 a month compared to nearer £585 a month for a repayment deal (where the loan as well as the interest is repaid). Over the life of the loan, the borrower pays £125,000 in interest on the interest-only deal - but only £75,377 on the repayment loan. This is, of course, something that borrowers might care to consider before opting for interest-only.

Although borrowers are not obliged to take out a savings plan at the same time as their loan, they will need to consider how the loan will eventually be repaid. The high volume of remortgaging in recent years has made it harder for lenders to keep track of repayment channels so the onus has switched from the lender to the borrower to make sure these are in place.

While some borrowers are gambling on house price increases to save them, others are pinning their hopes on a lump sum such as an inheritance. In the 1980s, borrowers routinely took out endowment plans alongside interest-only mortgages, with endowment mortgages accounting for 88 per cent of all loans in the second quarter of 1988 and repayment loans representing only 10 per cent, according to figures from the CML. With endowments now discredited repayment loans account for 83 per cent of first-time buyer deals, compared with 17 per cent for interest-only.

Loans UK would conclude that repayment loans are a safer bet, even though they cost about a third more in monthly repayments, because they guarantee that the original loan will be repaid by the end of the term. Nevertheless, interest-only deals are starting to creep back. This reversal of fortunes is partly due to the boom in buy-to-let. Landlords tend to prefer interest-only as they are likely to sell within a few years - plus only the interest element of their mortgage repayments can be offset against their rental income. But with the wide variety of mortgage and loan products available we would advice you strongly consider one of these before an interest only mortgage.