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Soaring interest rates are driving more people to consider interest-only mortgages

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Rising interest rates are placing pressure on household budgets, and some families are considering interest-only mortgages. While they could alleviate some of the challenges now, an interest-only mortgage could have implications over the long term.

In response to high inflation, the Bank of England (BoE) has increased its base interest rate over the last 18 months. This has led to the cost of borrowing rising.

For some mortgage holders, it’s meant their regular outgoings have increased sharply.

In fact, as fixed-rate mortgage deals come to an end, the BBC reports 1 million households will see their mortgage repayments jump by £500 a month by the end of 2026.

So, it’s not surprising that homeowners are looking for ways to cut costs.

According to Mortgage Strategy, the number of searches for an interest-only mortgage on a platform for brokers increased by 53% in June 2023 when compared to a month earlier.

So, could an interest-only mortgage be a useful option for you?

An interest-only mortgage could reduce repayments but you’d pay more interest overall

With a typical repayment mortgage, each month you pay the interest accrued and a portion of the outstanding debt.

In contrast, as the name suggests, you only pay the interest with an interest-only option. As a result, your monthly outgoings may fall.

Let’s say you borrow £250,000 at an interest rate of 5.5%, with a 25-year repayment mortgage, your repayments would be £1,535. If you switched to an interest-only mortgage with the same interest rate, your repayments would fall to £1,146.

So, an interest-only mortgage could help you manage your finances in the short term.

However, over the long term, you could end up paying far more in interest.

In the above scenario, with a 25-year repayment mortgage, you’d pay a little over £210,500 in interest, assuming the interest rate stayed the same. For an interest-only mortgage, it’d add up to more than £343,700.

While your short-term outgoings may fall by using an interest-only mortgage, you could end up paying far more overall.

Your debt won’t reduce in value if you have an interest-only mortgage

As well as potentially paying more, you also need to have a long-term plan when using an interest-only mortgage.

Assuming you keep up with payments, you’d eventually own your home outright with a repayment mortgage. This isn’t the case with an interest-only option – you’d still owe the same amount you borrowed at the end of the term.

So, you need to think about what you’ll do when the term ends. There are several options you could weigh up, including these three.

1. Take out another mortgage

As your current mortgage ends, you may choose to take out another mortgage on your home – this could be an interest-only or repayment mortgage.

You’ll need to reapply for a mortgage, and you should keep in mind that you may not receive the same terms as your existing deal. For example, the interest rate offered may not be as competitive.

You should also consider how your circumstances may affect your mortgage application. Many lenders will want mortgage holders to repay the debt before they retire. So, taking out a mortgage beyond retirement age could limit your options.

Usually, you can lock in a new mortgage deal up to six months before your current one ends.

2. Pay off the outstanding debt with savings

While paying an interest-only mortgage, you may take other steps to build up capital so you can pay off the outstanding debt.

You may set aside savings or invest with the view of paying off your mortgage in the future.

This option could still mean you own your home outright at the end of the mortgage term while providing you with more flexibility.

It’s important to consider what could happen if things don’t go to plan. While investments have historically delivered returns over the long term, what would happen if the investments you earmark for paying off your mortgage underperform?

3. Sell the property

Another option is to sell your home. You would need to use the proceeds to repay the outstanding debt.

As property prices have increased over the medium and long term, you could make a profit. If homeownership is a goal, you may use the profit as a deposit on another property or even buy one outright if you’re in a position to do so.

Contact us to talk about your mortgage

If you have questions about which type of mortgage may be suitable for you, or would like help securing a mortgage that suits your needs, please get in touch.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

Soaring interest rates are driving more people to consider interest-only mortgages

Approved by The Openwork Partnership on 05/09/2023.