Interested in interest only?

Traditionally, the way of paying your mortgage loan – as with most other forms of repayments – was to pay a combination of the capital you borrowed and the interest accrued on it at the chosen rate from the lender. In the 1970s and 1980s, it became popular to simply repay the lender’s interest but take an investment plan designed to repay the capital at the end of the plan and maybe even provide a bit more cash.

It’s well documented that this didn’t always work out and many were, and still are, left with a shortfall, meaning that the funds in the investment plan didn’t clear the balance at the end of the mortgage term.

A more worrying trend started in the early 2000s with many cancelling their investments in the face of negative press, often without financial advice and some lenders even encouraging borrowers to take ‘interest only’ mortgages without any plan to repay the capital at all – except selling the property.

In recent years, regulation has largely stopped this practice however, there are many people from all these scenarios who have reached, or are approaching, the end of their term without a plan to repay the capital.

So what can they do? There are several options.

The first option is to sell up – most property would have increased in value significantly since the mortgage was taken – and downsize; this being the process of then buying a new cheaper / smaller property either outright with the sale proceeds or with a small manageable repayment mortgage. This works if you have children who have flown the nest and a smaller property will do or if you are happy to move to a less expensive area.

The second could be to make use of existing assets – other property or standalone investments / savings, even a pension lump sum – to repay the balance. Clearly, this may not be ideal unless you have lots of spare assets and / or cash. You could take out a new investment however, this would need to grow quickly and that could be very risky!

For those aged over 55 – and the timeframe means this is the case for many – the equity release or lifetime mortgage option is viable, though only if you have a minimum of 50% equity in your property. This enables you to refinance without making further repayments, if required, and extend the term until you are either ready to sell or for the rest of your life. You can even draw a little more, so long as you have the equity in the property however, it needs to be born in mind that interest is accumulated over the term at rates higher than current mortgage rates and this will be deducted as a lump sum upon sale of property or death.

Younger interest only borrowers, and potentially those older ones too, could simply switch their mortgage to a repayment one. This usually incurs a minimal administration fee from the lender (maybe £150 or so); it is a foolproof solution, so long as you can manage the likely increase in monthly outlay.

May 2018