The numbers from the Council of Mortgage Lenders show that interest-only mortgages are becoming more and more popular. From January to March 2002, interest-only mortgages made up 9% of all new loans. From October to December of 2005, the number of new interest-only mortgages went up to 23 percent. During the same time period, the number of first-time buyers who choose interest-only mortgages went from 6% to 15%.
This rise has a good reason: the monthly payments are much lower than they would be with a repayment mortgage. All you have to do is pay the interest. You don't have to pay back the capital until the end of the mortgage term, when the whole thing is paid off.
With an interest-only mortgage, you don't have to change things like how often you eat out or where you go on vacation. This makes having a mortgage very affordable. But we think that a lot of people could be in trouble in the future if they find out that they didn't start saving for this lump sum payment soon enough.
The Financial Services Authority (FSA) is worried that homebuyers might get an interest-only mortgage and not save enough to pay off the capital. As a result, mortgage lenders have made it harder to get an interest-only mortgage. Before they will lend you the money, you have to show proof that you have another way to save up for the capital. Pensions and Individual Savings Accounts (ISAs) are two of the most common ways to save money. These are regular payment plans that could help you save more than the amount you put in. They could also fail, though. The biggest risk is that the buyer will stop saving once the mortgage has been agreed upon.
If a borrower doesn't save enough money to pay back the capital, he or she would have to sell the house and buy a cheaper one when it's time to pay back the capital. The FSA and lenders don't want to be in this situation, especially since property prices are hard to predict.
In the 1970s and 1980s, interest-only mortgages were very popular. Homebuyers would get an endowment policy to cover the capital repayment at the end of the term. But recently, we all heard in the news that endowment policies were not doing as well as they were supposed to. Many borrowers were not able to pay back the capital because the endowment did not cover enough. People thought they were a "guaranteed" way to save money, but they didn't work out. In the same way, there's no way to know for sure that an investment will have done as well as it needs to in 20 years when it comes time to pay back the capital.
When people realised that endowment policies hadn't done as well as expected, the idea of getting an interest-only mortgage and a separate way to save money fell out of favour. Now, repayment mortgages are the norm. But according to the statistics that were just released and talked about earlier in this article, it looks like things may be changing again. Some people have no other choice. Many people can't afford to pay off their mortgages in full because house prices are too high.
So it looks like interest-only mortgages will become a lot more popular again, but we think mortgage lenders could do more to help homebuyers see the other options they have. For example, a mortgage doesn't have to be longer than 25 years. The term can be stretched out to 30 or even 35 years, which would help a repayment mortgage's payments a lot.
At 4.9 percent, it will cost GBP731.69 per month to pay back a GBP125,000 mortgage over 25 years. If you instead spread the loan out over 35 years, the monthly payment drops from GBP103.53 to GBP628.16. That can make the difference between not being able to pay a mortgage and being able to pay it.
You can now overpay on many mortgages if you have the money to do so. So, just because a mortgage is for more than 35 years doesn't mean that it will take that long to pay off. Also, many people who buy homes move every eight to ten years, so the mortgage never has to be paid off in full. Then it's a good time to reevaluate how much you can afford to pay each month.
There are also other choices, such as a mortgage where you pay back half of the principal each month and the rest at the end. It means that you get a head start on paying back the capital, and you can always renegotiate your mortgage if you feel like you can pay more each month.
Our most important piece of advice is that you shouldn't try to decide on something as important as a mortgage without first talking to a professional. There are many ways to solve the problem, so it's best to get a full picture from someone who knows the market well.
