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If you want to reduce your monthly mortgage repayments and have a solid repayment strategy to pay off the mortgage later down the line, moving from a capital repayment to an interest-only mortgage can be the right move.
This guide explores everything you need to know about switching to an interest-only mortgage in the UK.
What Is An Interest Only Mortgage?
With an interest-only mortgage, you only repay the interest on your mortgage every month throughout the term.
Your monthly repayments will be significantly lower than repaying capital and interest together, and it’s an excellent way to keep costs low throughout the mortgage duration.
However, you’ll owe the full amount you borrowed at the end of the mortgage term.
You’ll need an effective repayment strategy or plan to repay the lender the original capital as a lump sum, and the lender will need to agree with it as part of the application process.
Most lenders allow various repayment strategies, ranging from reselling the property to savings and investments.
Can You Switch To An Interest Only Mortgage?
Yes. Most lenders will let you switch to an interest-only mortgage if you’re on a repayment or capital and interest mortgage, provided you can meet their criteria.
Things that lenders will consider when making their decision include:
Your Repayment Strategy
The repayment strategy is a plan you’ll need to cover the final balance you’ll owe the lender at the end of the mortgage term.
You’re responsible for having this plan in place when taking out an interest-only mortgage, and the lender must approve it.
You must also maintain the repayment strategy throughout the loan term, ensuring you remain on track to repay what you borrow.
The best repayment strategy will depend on your situation and your lender, with options including a remortgage, selling the property, investments that generate cash, or saving each month.
Each lender will have different criteria, but you’ll need to show proof that your plans are realistic.
Some lenders may not accept certain repayment strategies and may not allow you to switch.
Equity
Lenders will carefully consider your equity or how much of the property you own outright.
Generally, interest-only mortgages tend to have a lower loan-to-value (LTV) rate than repayment mortgages.
The LTV expresses the percentage you own vs the percentage you still owe the lender as a percentage.
You must have enough equity to meet the lender’s minimum equity requirements.
If your LTV is high, you may have to wait until your equity increases or the property’s value increases before switching to an interest-only mortgage.
Income and Credit History
Most lenders have high-income requirements for interest-only mortgages, and you may need to be earning at least £75,000 for them to allow you to switch.
However, some lenders don’t have any minimum income requirements.
Like other mortgages, lenders will also scrutinise your credit history when deciding whether you can switch.
Interest-only mortgages are riskier for lenders since they must wait for many years before you repay the actual loan.
They’ll consider your credit history more carefully to determine how you handle money and whether you repay your debts on time.
Is Switching To An Interest Only Mortgage Right for Me?
An interest-only mortgage may not be suitable for most people because you need a reliable repayment strategy to make it work.
Here are a few benefits and drawbacks of switching to consider when making your decision:
Benefits
- Low Monthly Repayments
You’ll only make low monthly repayments since you’re only paying off the interest instead of the loan itself.
It’s one of the biggest advantages of switching and can be beneficial if you’re struggling with monthly repayments.
- Temporary Switch
Some lenders allow temporary switches to interest-only repayments, making things easier in periods of financial difficulty. It can lower your monthly repayments for a short period, usually 1 to 2 years.
- Flexibility
You’ll have the flexibility to choose what to do with your money with an interest-only mortgage instead of tying it up in the property.
You can invest what you’re saving monthly and make profits, especially if the interest rates are low.
Drawbacks
- High Risk
Even with a well-planned repayment strategy, there’s always the risk of not ending up with the money you need to clear the loan at the end of the mortgage term.
You’ll need a huge sum to repay the loan in a lump sum, and things can get tricky if your repayment plan performs poorly or falls through.
- Negative Equity
In case the value of your property drops, you’ll end up repaying a bigger loan than what your property is worth, which is referred to as negative equity.
You’ll have a greater risk of negative equity with an interest-only mortgage than with a repayment mortgage because you’re not reducing the value of your debt, only the interest.
- You’ll Repay More Overall
Although an interest-only mortgage is an excellent way to keep costs low, you’ll pay more overall interest than a repayment mortgage.
Mortgage interest is charged on the total amount you owe, and since the amount you owe doesn’t reduce, the interest you pay over the full term will not change either.
Interest Only Mortgage Alternatives
If you’re struggling to afford a capital repayment mortgage or you want to save money on immediate monthly outgoings, there are other options to consider before switching or if you don’t qualify for switching.
These include:
Mortgage Holidays
Also called a payment deferral or freeze, a mortgage holiday allows you to take a break from your monthly repayments for some time.
It can also involve reducing your monthly repayments, usually for a short period, like three months.
Part and Part Mortgage
This type of mortgage involves paying part of the mortgage on an interest-only basis and part of it on a repayment basis.
However, you may still pay more interest, and although the amount due at the end of the term can be lower, you’ll still need a repayment strategy to cover it.
Switching To An Interest Only Mortgage Final Thoughts
If you’re considering switching to an interest-only mortgage, consult a mortgage adviser before taking the plunge.
They can offer tailored advice that suits your unique situation, help you with the application process and provide alternative solutions if you don’t qualify.
Call us today on 03330 90 60 30 or contact us. One of our advisors can talk through all of your options with you.
