Around one in five homeowners in the UK are currently on interest-only mortgages – and many have no plan to pay down their debt. But if you owe potentially hundreds of thousands of pounds on your loan and your mortgage term is running out, what options do you have?
New data from the Council of Mortgage Lenders shows 1.9 million borrowers are currently on interest-only deals – meaning their mortgage repayments only cover the interest they’re charged, but never reduce the size of the loan they’ve taken out.
With many of these mortgages granted on 10 or 20-year terms in the 2000s, the Financial Conduct Authority (FCA) previously estimated that around 600,000 interest-only loans are due to expire by 2020.
Which? explains how interest-only mortgages work and what you can do if you’re facing the end of your mortgage term.
- If you want help with remortgaging your interest-only loan, you can get impartial, expert advice by calling Which? Mortgage Advisers on 0808 252 7987.
How do interest-only mortgages work?
On an interest-only mortgage, borrowers repay the interest that accrues each month on their home loan but don’t repay the amount that has been borrowed. This means that over the life of the term, the size of your mortgage won’t decrease as you make payments.
While few interest-only home loans are now available, around 1.9 million Brits remain on interest-free arrangements. This is a significant decrease from 2013, when 3.2 million owners were on an interest-free mortgage, according to the Council of Mortgage Lenders.
After a 2013 review by the FCA, lenders were obliged to warn homeowners whose loans were due to expire in 2020. The review found that 90% of borrowers had a plan to repay their loan, but 10% did not.
Find out more: Interest-only mortgages and repayment mortgages – the ins and outs
What if my term ends on my interest-only loan?
If you are on an interest-only arrangement, it’s critical to have a plan in place for when your mortgage term ends. Depending on your circumstances, a number of options may be available to you.
If you have the available cash, you may be able to repay your mortgage amount in full by putting your money into savings or investment products over the course of your mortgage term.
Options for growing your cash savings may include savings accounts, cash Isas, stocks and shares Isas, investment bonds or unit trusts. Each will offer a different rate of return and level of risk, so do your research to ensure the product meets your needs.
To work out whether your savings plan will meet your target, take your mortgage amount and the length of your term, then add in the different rates of interest or growth you could expect over that time. It’s worth calculating this amount on both the lowest and highest interest rates that might be possible, so you have an understanding of the best and worst possible scenarios.
Since 2014, all applicants for interest-only mortgages have been required to show evidence of a repayment plan which will allow them to pay off the mortgage in full by the end of the term.
Find out more: How to find the best savings account
If you can’t repay the loan in full, you may need to look into remortgaging your property. If you stay with the same lender, they can often switch you to a repayment mortgage or extend the term on your existing arrangement – though you may move to a higher interest rate.
Your mortgage provider is not allowed to offer to lend you more money without doing an affordability assessment – so if your property has lost value since you bought it, you may struggle to get a new deal.
Switching to a different lender offering a better rate may be attractive. But since 26 April 2014, lenders are required to do a full affordability assessment for remortgages, and also assess evidence of a repayment plan. This may make it difficult for someone on an interest-only mortgage from pre-2014 to get approval from a new lender.
On a repayment mortgage, paying extra on your mortgage helps you pay off the capital faster. But with an interest-only loan, overpaying will only reduce your future interest payments, not the loan itself, so this is unlikely to be a viable option for paying down your loan.
Find out how much your payments will be with the Which? Mortgage Advisers mortgage repayment calculator.
A lot of borrowers who bought a property with an interest-free mortgage in the late 1990s and 2000s were sold endowment policies – a type of savings plan that promised to accrue enough to pay off the mortgage. Many of these policies underperformed and often gains were eaten up by high commissions and fees.
But if you have an endowment policy in place, it’s worth checking the latest ‘maturity’ projection figure – how much you’ll have available when the policy expires.
If you think your endowment policy was mis-sold, you can find out your rights to make a complaint.
If there’s no way for you to repay your loan or remortgage, you may need to consider selling your home. The proceeds of the sale can go towards paying back your interest-only mortgage in full. If your property has grown in value, you may be able to use the profit towards buying a cheaper property. But be careful – if your property is worth less now than when you bought it, you’ll be on the hook for the shortfall.
In specific circumstances, you may consider using equity release to pay back a portion of your loan – but this option has significant downsides.
Equity release often comes in the form of a ‘lifetime mortgage’, which is essentially a second loan against your property. You won’t have to pay interest on this second loan, as repayments are ‘rolled up’ into your mortgage, which continues until you die or go into care. Your estate will then owe the lender the total borrowed, as well as the compounded interest – which may result in a significant debt.
Find out more: Is equity release right for you?
Your home may be repossessed if you do not keep up repayments on your mortgage.
Which? Limited is an Introducer Appointed Representative of Which? Financial Services Limited, which is authorised and regulated by the Financial Conduct Authority (FRN 527029). Which? Mortgage Advisers and Which? Money Compare are trading names of Which? Financial Services Limited.