An interest only mortgage will allow you to make monthly payments just to cover the interest on the money you have borrowed. Unlike a traditional repayment mortgage where payments consist of both capital and interest, with an interest-only mortgage, you will only pay the interest and the balance of the loan will therefore not decrease.
There are various reasons why an interest only mortgage may be appealing:
- Lower monthly payments: this means the loan would be more affordable on a monthly basis
- Short-term purchase: the borrower may be planning to sell the property in the short term and downsize to a cheaper property
- Investment purposes: the borrower could be planning to invest the money that would be used to pay the capital payments elsewhere
Risks and considerations
- Balance of mortgage will remain outstanding at the end of the term: as you are only paying the interest on the mortgage, the mortgage balance will remain the same and will be repayable at the end of the term
- Equity Building: as no capital is being paid during the term of the mortgage, the equity for the borrower will not increase unless the property value increases. This means they may have less equity available for the future, which could be problematic if the value of the property decreases
- Interest Rate Adjustments: if the interest rate loan is variable, borrowers may find their monthly payments increase if mortgage rates rise
- You will not fully own your own home at the end of the term: A lender will require you to pay the mortgage balance at the end of the term. This may mean you need to sell your property to repay the loan
- Investment Returns: if you choose to invest your capital repayments in an investment policy, the growth may not be enough to repay your mortgage at the end of the term
- Part interest only and part repayment: Many lenders will offer a two-part loan which means you can have part of the mortgage on interest only and part on repayment. This allows you to build up some equity in your property whilst keeping your monthly payment low
Interest-only mortgages may not suit everyone, and it is important to fully understand the terms, risks and long-term financial implications.