While interest-only mortgages have become less popular, millions of people have one and need a repayment strategy in place. If you do have an interest-only mortgage it’s important to review your plans as figures suggest almost half of borrowers will experience a shortfall.
According to the Financial Conduct Authority (FCA) over the next 30 years, 2.6 million interest-only mortgages will be due for repayment. While 90% have a repayment plan, the FCA estimate that 48% will not have enough money to pay off the loan. Half of the shortfalls are expected to be over £50,000, potentially leaving families struggling financially.
As the name suggests, with an interest-only mortgage, you’re only serving the interest on the mortgage. This reduces monthly outgoings. However, you are not reducing the amount you borrowed. As a result, when the mortgage term ends, you still need to pay off the initial loan, and you need a plan for how this money will be repaid.
Even if you have a plan in place, you should regularly review this to make sure it remains on track. If investments have not performed as well as expected, for instance, you could face a shortfall. Knowing there is a potential gap sooner means you have more options to bridge it. If you reach the end of an interest-only mortgage term and can’t pay back the amount you owe, other assets may be at risk.
If you have an interest-only mortgage, there are many ways you can create a repayment plan to fit into your aspirations. Here are six options to consider.
When you took out an interest-only mortgage, an endowment policy may have been offered alongside it. Taking out an endowment policy was particularly popular during the 90s.
It’s a type of investment product that covers a fixed period, in this case, linked to your mortgage term. It offers a way to invest to pay off the outstanding mortgage debt at the end of the term with a lump sum. However, as with all types of investments, returns from an endowment policy cannot be guaranteed. As a result, if you do have an endowment, it’s important you track performance and understand the risks associated. Investment performance that doesn’t meet your expectations could mean the lump sum won’t be large enough to pay off the loan.
You don’t have to use an endowment policy to save or invest to pay off an interest-only mortgage. You can use other products to build up a lump sum that can then pay off the loan. This may include using ISAs or an investment portfolio.
If you choose to save, your money will earn interest. However, interest rates are low and it’s likely your savings will lose value in real terms once inflation is calculated. Investing could help your money outpace inflation, but it does come with investment risk and the value of your assets can fall. As a general rule, investing should be considered for goals that are more than five years away.
You may also want to consider whether pension investments could be used to pay off your mortgage once you reach retirement age.
If you’d like to discuss how your assets could be used at the end of an interest-only mortgage or which investments are appropriate for your goals, please get in touch.
If you’re in a financial position to make additional mortgage payments, this can help reduce the loan amount. Overpayments will go towards reducing the debt, rather than interest. Therefore, regular overpayments, or a one-off lump sum, can help ensure you’re on track to pay off your mortgage.
Make sure you check the terms of your mortgage before making an overpayment. You can usually pay off 10% of the outstanding amount without incurring any fees. However, this isn’t always the case.
If you need more time to repay the loan, using another interest-only mortgage or extending the term may be an option. You will need to continue making interest payments if you choose this solution. As a result, it will end up costing you more.
You will need to apply for a new mortgage, this will include the provider reviewing your ability to make repayments. You should also ensure you have a long-term plan for paying off the loan too.
If you’re nearing retirement and an interest-only mortgage is coming to an end, one option to explore is a retirement interest-only mortgage. These mortgages don’t have a term, but will run throughout your life or until you sell your home. It can be a useful option if you don’t have any way of repaying the loan. However, it means throughout retirement you will need to continue making interest repayments, which could increase, so this needs to be factored into your retirement plan.
If you’re in a position to do so, switching to a repayment mortgage can make sense.
This is where you’d pay off some of the amount borrowed along with the interest accrued each month. Assuming you keep up with mortgage repayments, you’d pay off the loan at the end of the mortgage term. However, your monthly payments will rise as a result. You should ensure you can meet this financial commitment. Mortgage lenders will also check you’re in a position to meet payments before they approve your application for a repayment mortgage.
Finally, you can sell your home to pay off any outstanding debt.
The main risk is that your home is worth less now than when you bought it, leaving a shortfall. However, despite short-term dips, house prices have climbed over the last few decades. So, if you’ve held an interest-only mortgage for several years, you’ll probably benefit from rising house prices. As a result, you should be able to sell your house and still have some money left over after repaying the debt. This could be used to purchase another home or act as a deposit.
Of course, the drawback here is that you’ll have to move. For some, this can make sense. But, for others, selling their home will be the last resort. If moving home doesn’t fit in with your plan, an alternative may offer a solution.
If you have an interest-only mortgage or are considering taking one out, a repayment plan is essential. Please contact us to discuss your plans and the options available with one of our team.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.