Interest Only Mortgage

The Interest Only Mortgage has been slated in the UK press due to the miss-leading way they were sold as Endowment Mortgages in the late 90’s.

An Endowment Mortgage is simply and interest Only Mortgage with an investment policy attached to it for the purpose of repaying the mortgage at its maturity. The basic problem was that consumers were unaware of the risk of the policy’s non-performance and therefore were left with significant shortfalls at the end of the term. The Financial Services Authority (FSA) have since tightened up the sale of the mortgages and the term has all but disappeared from the UK mortgage market.

Interest Only Mortgages on the other hand (which is essentially all an endowment mortgage ever was) have flourished as confusion has subsided and they are now presented for what they are. An ongoing source of funding with lowest possible payments with full repayment of the capital at the end of the term.

Interest Only Mortgages In a Nutshell...
Every mortgage has 2 parts to it. Capital and Interest.
Interest
Simply the charge or fee levied for the privilege of borrowing that money. The Lenders Profit/Income.
Capital
The amount borrowed which can either be repaid in small amounts over the life of the loan (repayment-Mortgage) or in a single lump sum (Interest-Only Mortgage) at any time.

How Interest-Only Mortgages Work.
Put simply you only pay the interest portion of the loan during its life or term and the Lump sum is repaid at the end. Generally through the sale of the property.

Example;
Interest-Only Loan
If you borrow £125,000 at 6% interest over 25 years.
Your Interest Only payment would be £625 per month for 25 years PLUS you would still owe the full £125,000 at the end of the 25 years. ( interest Only calculator )

Capital & Interest Repayment Mortgage
If you borrow £125,000 at 6% interest over 25 years.
Your repayment would be £805.38 per month for 25 years BUT you would OWE NOTHING at the end of the 25 years. ( Repayment Calculator )

Why Use an Interest-Only Mortgage
- The Biggest Advantage is for cash-flow as the payments are obviously lower.
- Mainly used for Buy-to-let Properties where the goal is income generation rather than paying off the property. There is greater tax advantages to this method particularly for business people.
- Helps get onto the property ladder and can often be cheaper than renting a property (think of it like renting of the bank).
- Often used for a short term for credit repair. After a couple of years, credit score has improved offering lower mortgage rates and therefore switch back to repayment mortgage.

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