Interest-only mortgages have received a lot of negative press in recent years, but they are still a useful option for certain borrowers.

There was a huge backlash against interest-only when the watchdog found that many people had been sold the loans without the lender checking if they had any means of paying them back. 

They once accounted for a large share of the market – by 2007 a third of all the mortgages were sold on an interest-only basis. But when the regulator looked at these cases it found that some borrowers didn’t understand they were only paying the interest and so would not own their homes at the end of their mortgage term. These borrowers were distressed to learn that they would probably have to sell their home at this point in order to pay their lender back.

The resulting clampdown in 2012 saw most high street lenders pull out of interest-only altogether or dramatically restrict their criteria so that only the wealthier clients with very large deposits would qualify.

Simon Checkley, managing director of Private Finance, says: ‘Despite the widespread misuse of interest-only in the past, which gave the products such a bad name, they remain a useful financial planning tool for the right kind of borrower. Luckily, there are plenty of lenders that recognise this and will still provide these loans in the right circumstances.

‘If a large proportion of your income comes from bonuses, interest-only can be a great way to keep down your monthly costs, allowing you to pay off the capital in large chunks at the end of each year.’

They also suit those who are confident investors. Borrowers who work in finance or are comfortable with investment risk, may decide to keep their monthly bills low and invest the money they would have put towards capital repayments into the markets. 

In order to do this you would need to be confident that you could earn a higher return from the markets than the interest rate you are paying on the mortgage. It helps that mortgage rates are at record lows, so your investments would probably have to beat an interest rate of around 2 per cent. It’s a risky strategy, but one that many experienced investors employ to their advantage.

Another option is known as ‘bullet repayments’. Metro Bank offers this structure. Take, for example, a £1m mortgage on a property worth £2m. The borrower would only pay the interest on the loan each month, but every year they would make a ‘bullet repayment’ to clear some of the capital. Over a 25 year mortgage term they would pay back the capital completely so that they own the property outright. 

So, based on Metro Bank’s five-year fixed at 1.84 per cent, the borrower would pay £1,533 a month for 11 months of the year. On the 12th month they would pay £40,000, which is 1/25th of the total debt, plus the usual £1,533 in interest. After 25 years the loan would be fully repaid.

Checkley says: ‘This type of mortgage is particularly useful for professions where income is high but inconsistent such as city workers with a relatively low basic wage but high bonuses or law firm partners who receive annual profit distributions.’
Generally the maximum loan-to-value you could get for an interest-only mortgage is 85 per cent, so you would need a 15 per cent deposit. However, some lenders are stricter.

Most lenders also require that you have already paid down a minimum amount of equity in the property before they will allow an interest-only loan – typically this is at least £150,000.

Some lenders are happy to allow the sale of the property as a repayment vehicle whereas others will require a more traditional investment such as a pension, endowment or ISA.

Share this article: