A guide to interest only mortgages by our expert Andrew Milnes

At first glance, interest-only mortgages may seem like an appealing option for homebuyers who don’t want to commit to large monthly repayments. An interest-only mortgage is a mortgage agreement where the borrower pays the “interest-only” each month as opposed to having it on a capital and repayment basis.

Payments will be less than on a repayment mortgage, but at the end of the term the homeowner will still owe the original amount borrowed from the lender. The majority of people in a salaried position prefer to pay a fixed lump sum month-by-month, gradually reducing their debt and simultaneously creating equity in the property. However, this mainstream approach isn’t for everybody, and lenders are increasingly open to looking at interest-only mortgages if there is a rationale for doing so.

As with any large financial commitment, it’s important for prospective buyers to seek expert advice to make sure an interest-only mortgage is suitable for their individual circumstances.

When it comes to eligibility, there is no hard and fast rule, however, interest-only mortgages are not typically suitable for first-time buyers who are often looking to borrow at a high loan to value (LTV), create equity in the property, and slowly but surely reduce the debt.

There are, of course, exceptional circumstances where a first-time buyer might be considered for an interest-only mortgage. Perhaps if they are self-employed and get an annual dividend, have a high net worth or have the means to pay large instalments at structured intervals. But these cases are few and far between.

What does a robust repayment plan look like? It’s fair to say that anybody that opts for an interest-only mortgage needs a structured repayment strategy.

They should ask themselves these questions: How will I repay the original capital borrowed at the end of the mortgage agreement? How can I get debt reducing throughout the agreed term?

Repayment strategies can come in many different shapes and sizes, from investment plans to equity release in additional properties or lump sum payments from a pension. And while most lenders need to see evidence of a robust settlement plan, some may accept the sale of the mortgaged property or downsizing as the main repayment vehicle. But if borrowers were to go down this route, there are some very clear guidelines in place, including:

Annual income. Lenders will only consider this a viable option for people who earn between £75,000-£100,000 per year, so borrowers are not going down the interest-only route for cash flow purposes, instead because it is best strategy for them.

Equity: Location depending, the borrower will need to have a certain level of equity in their home, especially if downsizing is to be feasible. Realistically, the homeowner would need to have built up equity of at least £250,000 to ensure affordability for a smaller property.

If prospective buyers can’t afford a mortgage on a repayment basis, they are probably stretching themselves too far, especially in the current climate, while rates are so low.

If the borrower has the financial means, the possibilities could be endless. But if there is no repayment plan in place, the chance of securing an interest-only mortgage is very limited.

*Andrew Milnes is business principal at Mortgage Advice Bureau, Bingley. Contact: 01274 568832

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