According to UK Finance data, 908,000 pure interest-only mortgages were outstanding at the end of 2020, and 61% of mortgage lenders currently offer this type of loan.
Due to the pandemic, many people face financial difficulties, leading to the highest unemployment level for four years. The Office for Budget Responsibility has predicted that the jobless rate will be double the pre-pandemic rate when the furlough scheme ends on 30 September. This could lead to a rise in the popularity of interest-only mortgages.
But how do you ever pay off a loan if your monthly repayments only cover the accumulated interest?
What is an Interest-Only Mortgage?
As the name suggests, you only pay the interest that accrues each month with this type of loan. The size of your debt remains the same. For example, if you borrow £150,000 after two years of making monthly interest-only payments, the outstanding balance on your mortgage will still be £150,000. Depending on the deal you agreed with the lender, you must pay the entire sum in one lump sum at the end of the mortgage term, typically 30 years but maybe more or less.
In contrast, a homeowner with a repayment mortgage pays off the interest and a chunk of the debt each month. The outstanding balance gradually reduces until the whole sum is repaid at the end of the mortgage term.
How to Pay off an Interest-Only Mortgage
The Financial Conduct Authority has identified two peak periods when interest-only mortgages mature — 2027-28 and 2032. If your mortgage is due to be paid in the next six or seven years and you don’t have a plan in place to raise this lump sum, you could be in trouble.
Your lender should reach out to you a few years before your interest-only loan matures to check that you’re on track and able to repay the balance by the end of the mortgage term. Talk to your lender if you have concerns and don’t leave it too late! — a mortgage company can repossess your property if the debt is not repaid in full at the end of the mortgage term.
What are your options for paying off an interest-only mortgage?
- Use the equity you accumulate over the mortgage term to pay off the debt.
This is only possible if property prices rise sufficiently over the mortgage term to give you enough equity to pay off the total loan amount.
- Remortgage at the end of the mortgage term.
This will depend on your age and income. Most lenders will be reluctant to approve a loan that runs beyond your retirement age.
- Extend your mortgage term.
This would give you extra time to raise the funds required to clear the debt. However, there is no guarantee that your lender will approve your request.
- Increase your monthly payments.
Most mortgage lenders allow you to overpay by around 10 per cent each year. Overpaying will enable you to start paying off the capital as well as the interest.
- Move to a repayment mortgage.
Ask your lender if you can switch to a repayment mortgage. This will allow you to start reducing your debt each month. However, the monthly payments are likely to be higher.
- Sell your house.
If you are not able to repay the balance when it is due, and this is unlikely to change, there is little point in delaying the inevitable. Opt for a quick house sale, clear your debt and start afresh in rented accommodation.
If you believe that you were given poor advice regarding your interest-only mortgage — perhaps you did not understand what you were committing to. Or if the lender made no checks to ensure that you had a repayment plan in place — you can complain to the Financial Ombudsman Service (FOS). If the FOS finds that the lender acted irresponsibly, they will seek to put things right and put you in the position you would have been had you received appropriate advice. You may also be able to get help if your lender refuses to extend the loan term or allows you to switch to a repayment mortgage.
If you’re feeling overwhelmed by the prospect of repaying your interest-only mortgage, seek independent financial advice as soon as possible. Putting a plan in place or accepting that you will have to sell your house is much better than burying your head in the sand until your lender takes legal action to repossess the property.
