The number of interest-only mortgages available to people who want to buy a home to live in has nearly doubled in the past six years, according to new research from finance data provider Moneyfacts. But can you actually get one?
In May 2013, there were 102 ‘residential’ interest-only mortgages available. By May 2019, this had risen to 193.
These types of mortgages are prominent in the buy-to-let market, but for people looking to pay off just the interest on a loan for a home they live in, it’s much tougher to get a deal.
Despite the rise in the number of deals, Moneyfacts found that the approval rate for interest-only mortgages fell between 2013 and 2018, with stricter rules on affordability hampering people’s chances of taking out such a loan.
Which? explains the latest in the residential interest-only mortgage market, how you could get this type of loan – and the pros and cons of borrowing in this way.
Interest-only mortgage approvals fall
The most common type of residential mortgage is a ‘repayment’ mortgage, which sees you paying off both the interest you’re charged on your home loan, and part of the loan itself each month.
Interest-only mortgages only require you to pay off the interest. This means monthly repayments are lower, but you will need to pay off the entire loan at the end of your mortgage term.
Acceptable repayment strategies for many residential interest-only mortgages include a savings plan, an investment portfolio, a pension or other assets you plan to sell.
Approvals for these kinds of deals fell by almost 10% between the start of 2013 and the end of 2018. This decrease is even more significant in the context of approval rates for all residential mortgages, which rose by around 75% over the same period.
Despite this tumbling acceptance rate, there are a huge number of mortgage products available with an interest-only repayment method.
While there are 193 mortgage products that are exclusively available as interest-only, the total number of residential mortgage deals that allow interest-only payments as an option is 2,265 – almost half the total number of products on the market.
Can I get an interest-only mortgage?
We asked David Blake from Which? Mortgage Advisers for his expert take on the drop in interest-only mortgage approvals.
He told us: ‘These days, lenders are more wary of putting someone in a position where they would not be able to pay back their interest-only mortgage.’
This has led many lenders introducing have tougher affordability requirements for interest-only mortgages. According to David, lenders are more likely to approve you for an interest-only mortgage if you:
- Borrow at a 50% loan-to-value (LTV) ratio – this means you can only borrow 50% of a property’s value. You’ll have to stump up 50% deposit or (more likely) hold 50% equity to cover the rest.
- Hold a minimum of £200,000 equity in your property – if the repayment vehicle is the sale of the property.
- Have £50,000 annual income – to give lenders more confidence that you’ll be able to afford the repayment at the end of the term.
Interest-only mortgages for landlords
Although Moneyfacts’ new research relates to residential mortgages, interest-only deals are far more likely to be offered to buy-to-let landlords.
This is because rental income can cover monthly interest payments, and a landlord can sell a property at the end of their term to settle the loan.
Find out more in our full guide to buy-to-let mortgages.
What are retirement interest-only mortgages?
If you need a residential interest-only mortgage, perhaps because you already have one which is nearing the end of its term and you’re going to be unable to pay off the balance, a new type of product called the retirement-interest only mortgage (RIO) may work for you.
Of the 193 residential mortgages that have interest-only as the only repayment option, 43 are RIOs.
Unsurprisingly, these products require you to be in or approaching retirement, and usually over 55.
Most RIOs work the same as other interest-only mortgages, but the repayment vehicle will be the sale of your property when you die or move into long-term care. This means the affordability criteria might not be as strict.
- Find out more: retirement interest-only mortgages explained
Is an interest-only mortgage a good idea?
Since residential interest-only mortgages can be so difficult to secure, is it actually worth trying to get one?
Here are a few of the pros and cons. For more a closer look, see our full interest-only mortgage guide.
- Lower monthly repayments – with a repayment mortgage, you have to pay interest and capital back each month. With interest-only mortgages, it’s just the interest.
- Lower chance of entering arrears – because you have less to pay each month, it will be easier to make the payments.
- Flexibility – most interest-only products will give you the option of making overpayments, which will pay off some of your loan balance.
- You could become a ‘mortgage prisoner’ – for a number of reasons, including strict affordability rules and lack of choice for older borrowers, you might struggle to switch to a repayment mortgage to settle the loan. This makes you a ‘prisoner’ of your current deal.
- Large bill at end of term – you will need to have a reliable repayment vehicle in place to settle the loan. This may have to be the sale of the property if you can’t switch to a repayment mortgage.
- Property value could decrease – making it very difficult to repay the final loan. Especially if you can’t remortgage.
Lenders are more cautious about approving residential interest-only mortgages, so you should only apply for an interest-only mortgage if you’re sure you will be able to.
Popular repayment methods include selling your property and downsizing, selling investments, and using savings.
But as David Blake told us, ‘the only way to guarantee a mortgage is paid off is by taking a repayment mortgage’.
If the value of your property decreases, for example, selling it may not cover the cost of your loan.
David advises anyone with an interest-only mortgage to make overpayments whenever they can.
Overpaying on an interest-only mortgage means choosing to pay back more than just the interest, and therefore chipping away at your actual loan balance. This will make it easier to pay it off when your term ends.