Interest only mortgages
An interest only mortgage is essentially a loan which never gets
repaid. Instead of the ‘usual’ situation whereby you take out a
mortgage/ loan and repay a part of it every month, and on top of that
pay off an extra amount [the interest portion], you are only required to
pay off the interest portion. So the amount outstanding is always the
same.
Note: With a standard, repayment mortgage/ loan, the amount owed
gradually decreases, so that towards the end of the loan period the
repayments are normally a lot smaller than towards the beginning of the
loan period.
Benefits and disadvantages of the Interest Only Mortgage
Some mortgage advisors will tell you that to take out an interest
only mortgage is a perfectly natural and sensible way to play the
housing and financial markets. For example you may be prepared to owe
the original 250,000 that you originally borrowed at the end of 25 years
if the value of your property has increased 10-fold – you may be
prepared to downsize your property at the end of the term, repay the
original loan amount and still have money in the bank, thanks to the
increase in house prices outweighing the original amount borrowed, when
inflation has significantly reduced the amount you originally borrowed
in real terms.
Another advantage of an interest only loan is of course that the
payments will be significantly lower than with a repayment mortgage,
because you are not paying anything over the minimum required to qualify
for the loan.
But there are disadvantages perhaps the biggest being that when this
type of loan is embarked upon it is often because the borrower is
stretching themselves to the limit of affordability, of what they can
afford to repay each month after taking into account their expenses,
outgoings and salary calculations – thus it can be a dangerous,
‘sub-prime’ category of mortgage. Not only has this but because your
monthly payment is purely an interest portion you are more vulnerable to
changes in the interest rate when the fixed term ends or if tied to a
variable rate to start off with.
Repayment Vehicles
An interest only mortgage is often considered alongside another,
often separate product, which is designed to pay off the loan amount at
the end of the loan period. This is usually in the form of a stock based
or savings based plan that you hope will mature to the full amount, and
hopefully more than the loan amount by the time the loan period ends.
This setup has been held responsible for mortgage misselling in recent
years. – The Endowment Mortgage was often touted as a superior mortgage
model – not only promising to pay off your mortgage at the end of the
term but also to provide a nice retirement nest egg to boot.
Unfortunately, due to fluctuation in the financial markets and bad
financial advice from many financial advisors mortgage customers in the
80’s and 90’s found that their endowments were not enough to cover the
mortgage amounts and were left owing money at the end of their mortgage
terms. This has led many to seek compensation for this endowment
misselling and the emergence of many specialist companies offering to
buy endowments for cash or to pursue compensation on your behalf. If you
are in this situation then proceed with care and take advice from a
properly qualified independent financial advisor.
Don’t forget, if you have an interest only mortgage you will never pay
it off – If you are desperate to get on the housing ladder and see an
interest only mortgage as your only affordable option you will be well
advised to at least consider a shorter tie-in period so that you can
switch to a repayment model sooner, or to find a flexible mortgage
product that will allow you to repay an amount from the mortgage total
each year at your discretion – but don’t forget to do this!
|
