Interest only mortgages

There was a time when homebuyers automatically chose to take out a repayment mortgage to pay for their home, but low interest rates and a thriving housing market have given rise to a new kind of mortgage: the interest-only mortgage.

What is an interest-only mortgage?

This is where repayments are made up entirely of the interest on the loan. When the mortgage term is complete, the capital originally borrowed is still outstanding. To cover the balance, borrowers are advised to make regular contributions into an investment policy alongside their mortgage repayments. This can be arranged by the mortgage provider, most commonly in the form of an endowment mortgage, an ISA mortgage or a pension mortgage.

How does it differ from a repayment mortgage?

With a repayment mortgage, you make monthly payments on the borrowed capital as well as the interest. With interest-only, however, your payments are made up of the interest alone, and you do not repay any of the capital until the mortgage term is complete.

What are the benefits of choosing an interest-only mortgage?

Because you are only paying back the interest on the loan, you will pay less each month than you would with a repayment mortgage.

What are the risks?

When the loan term ends, you still owe the lender the capital you borrowed at the start of the mortgage. If your savings or investments do not cover this debt, you face the possibility of having your home repossessed.

How do I know if this is the right kind of mortgage for me?

If you are unsure whether or not to opt for an interest-only mortgage, ask yourself the following questions:

1. Are you comfortable taking financial risks?
2. Does the idea of taking out long term investments interest you?
3. Would you be able to utilise other investments should there be a shortfall at the end of your main policy?
4. Are you confident that you can pay all your mortgage repayments in full and on time?

If you answered yes to all of the above, then an interest only mortgage could be suitable for you. If, however, you answered no to any of the above, or were unsure what your feelings were towards some of the questions, then you may find that a straightforward repayment mortgage will suit you better. Seek professional, independent financial advice if you are in any doubt about which to choose.

© AskFinancially.com 2008

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