How exactly interest only mortgages work
With it becoming increasingly difficult to get onto the housing ladder, even with the slightly lower house prices around at the moment, an interest only mortgage may seem like a good option that will allow you to get onto the housing ladder while also paying lower mortgage payments than a repayment mortgage requires from you.
An interest only mortgage is exactly that
One thing that you have to be very aware of before you think about taking out an interest only mortgage is that if you take out one of these mortgages you will literally only be paying the interest on your loan every month. While these payments are going to be lower than for a repayment mortgage it may actually turn out to be a false economy in the long run as you not only have to come up with a way of repaying the whole loan at the end of the mortgage, you will also be paying interest on the whole loan for the entire term of the mortgage.
Paying off the loan at the end
This part of an interest only mortgage has got many people in trouble over the years as the savings scheme they have employed has ended up not providing an adequate amount of money to actually be able to pay off the loan in full. For this reason many mortgage lenders now refuse to offer interest only mortgages.
What are the advantages and disadvantages of an interest only mortgage
If you look at all of the requirements of an interest only mortgage there really don’t seem to be any advantages of taking one out. In the short term it could provide you with lower mortgage payments, but in the long term these would be offset by you having to pay more into your scheme to provide you with your final payment.
Some of the disadvantages have already been touched upon above but it is worth reiterating them. As has already been mentioned, if you opt for an interest only mortgage then you don’t actually pay off any of the loan while you have that particular mortgage deal. Therefore it is entirely down to you to make sure you have some sort of savings scheme that you will put money into in order to build up the funds you will need in order to pay off the loan at the end of your mortgage term. If the value of your property drops and you find you need to move, you could potentially find yourself trapped in negative equity, which lenders will view as a risk. In order to offset this risk lenders will usually demand a larger deposit for interest only mortgages than for repayment mortgages so that there is a reduced likelihood of you going into negative equity.
If you decide to move home or you wish to switch to a repayment mortgage due to interest rates going up you may find you struggle as most investments that have any sort of decent interest rate also limit your access to the account and many have five or ten year lock-in periods that you have to leave your money in for in order to benefit from the savings deal. This could leave you with your investment locked away when you need it most for either a deposit or for mortgage payments.
When an interest only mortgage may be the better option
In a small number of cases you may have a repayment plan that will provide you with a return on your investment money that will not only provide you with the funds you need to pay off the loan at the end of the mortgage term, but will also more than cover the larger amount of interest you will pay over a repayment mortgage. If you are not going to be able to benefit from using your money in an alternative way then it is unlikely that an interest only mortgage is going to provide you with a better deal in the long term. So before you opt for an interest only mortgage, do the maths and see how much your repayments will be for an interest only mortgage and paying into your repayment plan compared to your single payment for a repayment mortgage.
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