Why you need a plan if you have an interest-only mortgage

Adrian Anderson - Anderson Harris

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Published: 27th March 2023

This Article was Written by: Adrian Anderson

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Interest-only mortgages were a popular property finance option before the financial crisis of 2007/8. Many of these legacy products were taken out without the mortgagor having a credible repayment plan and are now reaching the end of their term. It means some homeowners are facing the stark reality of finding the money to pay the lender the capital owed on their property.

What is an interest-only mortgage?

With this type of property finance, the homeowner only pays the interest accrued on the property loan. It typically brings a cheaper monthly payment, however, at the end of the mortgage, the homeowner has to pay the whole loan amount. So, if you took out a mortgage for a property in 1989 for £120,000 and have been paying the interest ever since you still need to find the £120,000 to retain the property when the term ends.

Why are interest-only mortgages becoming a ‘ticking time bomb?’

At the time, interest-only mortgages were an easier way to buy property. Many expected that they would have the money to pay off the capital owed when the mortgage’s term ended. While property prices have risen, the financial crashes and challenges of the past 16 years have meant many people still need to amass the necessary funds to pay off their capital.

There are many reasons for this. Common examples we’re seeing are:

  • People are not ready to sell and downsize to pay off the capital – particularly as younger family members are still living at home or elderly parents have moved in to be cared for.
  • The low interest rates over the past decade mean many pensions and other savings haven’t grown as hoped.
  • Anticipated inheritance may also have failed to materialise, given care costs for seniors and longer life expectancy.
  • People are having to work longer due to the cost of living, and need to stay in the property for work.

In 2014, The Financial Conduct Authority issued warnings about interest-only mortgages, and tighter affordability checks were introduced. Since then, significantly fewer interest-only mortgages have been available on the market. In recent years though, with the cost-of-living crisis, some lenders have switched customers to interest-only to ease their repayments.

What are the options as you face the end of your interest-only mortgage term?

Each mortgage holder’s financial situation will be different, however, typical options at the end of an interest-only mortgage term include:

  • Sell the property and downsize, paying back the capital owed.
  • Pay off the capital from savings or the sale of other assets.
  • Re-mortgage.
  • Use retirement mortgages or those focused on older borrowers.
  • Use equity release/lifetime mortgage.

Re-mortgaging and mortgages for older borrowers

There are some lenders on the market offering re-mortgaging, however, they are subject to tighter affordability assessments – particularly for those nearing retirement. Re-mortgaging at this stage of life is typically for a shorter mortgage term and may come with a higher interest rate.

There are fewer options available from the major lenders to people over 65, mainly because of limited income at that stage of life, although different forms of pension income may be considered. Smaller niche lenders, such as building societies, are coming to the rescue of older applicants. Do, however, expect rigorous affordability checks covering finances, health and lifestyle.

Equity release/lifetime mortgages

Equity release is a viable consideration for those typically over 60. It allows the homeowner to release cash from the value of their property or re-finance an interest-only mortgage. This type of mortgage is typically repaid after the borrower (or the last spouse in a couple) dies or goes into a care home, and the property is sold.

Unlike other property finance products, it is not income assessed and instead is calculated using the property’s value and the applicant’s age. The loan to valuation can be quite conservative and the rates are much higher than they were 18 months ago. This can be a viable repayment strategy for an interest-only mortgage for some borrowers, however only in certain scenarios. The market has become highly regulated in recent years, and more flexible payment options are available.

Equity release isn’t a ‘cheap’ solution but can be helpful for certain borrowers – particularly those who don’t have dependents to leave an inheritance to.

Why a plan is now essential

While options are available for those facing the end of their interest-only mortgage term, these depend on each individual’s financial situation. Also, the later you leave it to talk with your lender, the more challenging it is to find a solution which works for you.

Therefore, it is essential to get in touch with your lender as soon as possible and don’t ignore the letters they send you. Also, talk to an independent mortgage adviser about alternative options and the latest rates in the current property finance market.

The Anderson Harris team regularly advise people in this area and devise property finance strategies to support their later life plans. This includes advising on equity release and mortgages for older borrowers. Contact one of our specialists today on t: +44 (0) 20 7495 6633 or e: enquiries@andersonharris.co.uk.

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