What Do Mortgage Lenders Mean By Interest Only?

Taking an interest only mortgage out may offer a cheaper way to purchase a property or even a remortgage of your current abode than with the conventional capital and repayment mortgage. The reason being is that borrowers are only paying off the interest charged and not the capital. Low cost endowment policies such as interest only mortgages can be beneficial for a certain type of homeowner. The trick is to use these products with an eye towards repayment rather than just existing. The following will look at certain aspects like calculations of these mortgages to help you better understand them.

An example of interest only mortgage calculations would be as follows - someone borrowing £150,000 at 5% interest rate over 25 years would cost them £624 per month on an interest only basis, and £878 per month on a capital and repayment mortgage. The difference in monthly payments is plain to see. But, you don't get something for nothing and this is what some interest only mortgage holders have found to their cost.

The eventual repayment of the mortgage at the end of the term on the interest only loan will have only paid off the interest charged which would still leave the original £150,000 outstanding. Additionally, this debt will still need to be repaid; hence, a means of savings should have commenced many years ago to counter this. In comparison to this, as long as payments have been met then a repayment mortgage would have guaranteed to clear the debt.

Interest only mortgages have been around many years and have been very common in the heyday of low cost endowment policies predominantly during the 1980’s which were sold as repayment vehicles alongside them - more info found here.

So, what's the problem with interest only mortgage deals?
Some time ago the regulators removed the requirements stipulating that if borrowers took out interest only mortgages then the lender would have to ensure a suitable repayment vehicle was taken at inception and that monthly premiums were maintained. This was in the shape of low cost endowment policies.

The lenders even took the bold steps of taking possession of the endowment policies and keeping them in safe custody with storage facilities provided. Additionally, the mortgagee would put a charge on the endowment policy itself so that encashment could not take place without the knowledge of the lender.

However, as poor performance of these endowments became evident from 2000 onwards the sale of these life assurance policies declined.

People then began gambling on future housing price increases with the hope of this being a repayment possibility over increasingly longer terms. People with interest only mortgage deals and with no repayment of capital can have the major risk in time of falling property prices. This will result in their debt being greater than the value of their home. This can be dangerous.

It can also be an issue at the time repayment is required. If someone does not have the funds then a house has to be sold or a new mortgage has to be attained. The person has to be in a good financial situation for this conversion to a traditional mortgage and wish to pay out more interest on the same principle balance. It is not a very comfortable position to be in.

When someone gets closer to retirement and is starting to see less income, there is added concern over being able to pay off their debts. The only hope someone has in this situation is to have an endowment policy or savings plan that will get better over time or to sell the property and get what they can out of it.

After Retirement Interest Only Lifetime Mortgages
There is another type of interest only mortgage to discuss that would also benefit from low cost endowment policies, but rarely sees them. The interest only lifetime mortgage is set up for retirees for anyone 55 or over. It is usually put into effect for the life of the person; however, the FCA has started regulating these tighter too thus many providers have switched to a time limit of 10 years or 75 in which repayment is due.

The best part about the lifetime mortgage is only paying interest, but knowing that until you and your spouse decide to sell or one or both of you dies you can live in the home. It is only at death that you usually have to repay the full amount, which does not have interest tacked on since you have been paying it. Still, consider low cost endowment policies as a means of saving the home from sale.

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