Switching to an Interest Only Mortgage

With the cost-of-living crisis weighing heavy on most people, many mortgage holders are wondering if it would be better to switch to an interest only mortgage from their existing repayment deal. The attraction being the monthly cost is reduced when making an interest only payment compared to both interest and capital on the loan.

The temptation to save money at the moment is great and switching to an interest only mortgage seems like a no-brainer. However, it is often not the best solution for a plethora of reasons.

Let’s discover interest only mortgages and whether you should consider switching to one.

What is an Interest Only Mortgage?

An interest only mortgage is exactly as it sounds. You borrow the amount needed for your mortgage but instead of paying the capital back, you just make interest payments.

The outstanding balance remains for the entire term of the mortgage unless you make capital overpayments. You might be surprised to learn that interest only mortgages are normally more expensive over the term of a mortgage than a repayment mortgage.

This is because a repayment mortgage pays off the capital and as time goes by the interest payable on the loan amount reduces in line with the loan. With interest only mortgages the capital does not reduce so the interest is charged on the full amount of borrowing until the mortgage expires.

What Happens When an Interest Only Mortgage Ends?

When your interest only mortgage term ends, you will need to do one of the following:

• Remortgage to extend the mortgage term
• Repay the amount outstanding on the loan

A typical mortgage term over the last few decades has been 25 years so in most cases it is feasible to extend a mortgage term for another 5-10 years. This only works if you are young enough to qualify for a mortgage lender’s maximum age.

The most common outcome is for the mortgage to be repaid at the end of the term. An interest only mortgage can be repaid in a few ways, however by far the popular way is to sell the property.

However, Equity Release is becoming far more attractive as an option due to the no negative equity guarantee, permanent rights to reside and the fixed for life interest rates.

Interest Only vs Repayment Mortgages

On a like for like basis, repayment mortgages are more expensive monthly because you will be repaying the capital and the interest.

Repayment mortgages are particularly expensive during the first 10 years of a mortgage as the amount of money outstanding is higher compared to later mortgage years.

Towards the end of a repayment mortgage when you have cleared most of the capital, you should find that the monthly payment is greatly reduced compared to when you initially took the mortgage.

As mentioned, interest only mortgages are normally cheaper each month but much more costly over a full mortgage term compared to a repayment mortgage.

Reasons to Switch to an Interest Only Mortgage

There are several reasons you might want to change from a repayment mortgage to an interest only mortgage, these are:

• Because you no longer live in the property and wish to rent it out
• Because you are struggling to keep up with payments on your repayment mortgage
• Because you have an investment that will clear the capital when it matures

Depending on your specific circumstances, you may or may not be able to switch from a repayment mortgage to an interest only mortgage.

Can You Switch to an Interest Only Mortgage Temporarily

Yes, lenders will allow you to switch in some cases to an interest only mortgage on a temporary basis. Typically, this is a short-term option for those who want to make interest payments but cannot afford the capital repayment each month. For further information, read the U.K Government’s Mortgage Charter.

Each lender has different guidelines they follow when allowing you to temporarily switch to an interest only mortgage. The industry norm is to allow the switch to occur for a period of 6 months.

Alternatively, a lender may offer a payment holiday.

What are Payment Holidays?

For times of more extreme financial hardship, you may also be able to take a mortgage payment holiday. Mortgage payment holidays are, again, agreed at your lender’s discretion and are designed to give you breathing room by suspending payments on the mortgage for a period.

Lenders do not have to accept a payment holiday and may suggest alternatives to help you manage your finances better, such as:

• Extending your mortgage term to reduce monthly costs
• Allowing a payment holiday but increasing your monthly payments thereafter for you to
  catch up
• Allowing you to make capital only or interest only payments. It is rare a lender will opt for capital only payments and this is normally a last resort

The lender will also decide how long the payment holiday should be.

Can You Switch from an Interest Only Mortgage to a Repayment Mortgage?

Yes, you can switch from an interest only mortgage to a repayment mortgage and this is a common practice for those wishing to clear the capital on the loan before the term expires.

To switch to a repayment mortgage, you will need to pass the lender’s affordability calculation. You should speak to a mortgage broker in the first instance to find out if this option is feasible.

Can You Borrow More on an Interest Only Mortgage?

Yes, providing you pass a lender’s stress test, and the property has sufficient equity to cover the extended borrowing you can borrow more on an interest only mortgage.

Once again, a mortgage broker is ideally placed to process the calculations for you and recommend the best course of action.

How a Mortgage Broker Can Help You Switch

Mortgage brokers have a diverse range of solutions available to help you with any mortgage situation. You might be surprised to discover options that you had not considered or did not know existed.

Boon Brokers is a Whole of Market Mortgage, Insurance and Equity Release Broker. Boon Brokers provides fee free mortgage advice and arrangement.

Contact Boon Brokers to discuss switching to an interest only mortgage today.