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28 Dec 2019

How to tackle your interest-only mortgage in 2020

Which? reveals the most popular options for paying off an interest-only mortgage

More than 40,000 interest-only mortgage terms will end in 2020, but thousands of homeowners don't know how they'll pay their balance.

Specialist mortgage provider Kensington forecasts that 40,943 homeowners will have to pay back their interest-only mortgages next year.

But a Which? survey has revealed that one in 10 interest-only mortgage customers don't know how they'll pay their debt off.

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The interest-only mortgage crisis

At the end of an interest-only mortgage, you are faced with a bill for the entire amount you borrowed.

Since you've only had to pay interest, not capital, over the course of the mortgage, costs may have been low from month to month. But for many, the large bill at the end is not easy to pay.

Some interest-only mortgage customers end up as 'mortgage prisoners' - unable to remortgage due to stricter lending criteria and stuck paying high standard variable rates.

Others, like one member who spoke to Which?, suffer because their homes have fallen in value.

In mid-December, a group of mortgage prisoners started legal action against the companies they hold responsible.

Some mortgage prisoners could win compensation from overpaid interest, but if your interest-only mortgage is coming to an end soon, this won't be enough to help you.

How will most people repay their interest-only mortgages?

There are several approaches you can take to paying off an interest-only mortgage. The chart below shows which are most popular, according to our June 2019 survey of 1,011 members of the public.

Here, we look at how each approach works and whether it is right for you.

1. Overpayments

A quarter of people plan to settle their interest-only mortgage balance through making overpayments.

This is simply choosing to pay more than your required amount each month. Most lenders will allow fee-free overpayments up to a certain amount (often 10% of your overall balance per year), and charge fees for any overpayments above that.

In most cases, overpayments will be deducted from your mortgage's capital balance, making the final bill more manageable as a result.

You could, in effect, turn an interest-only mortgage into a capital-and-interest repayment mortgage by overpaying a certain amount each month.

However, be careful not to pay more than you can afford. Lenders are obliged to ensure your monthly mortgage payments are affordable, but the amount you choose to overpay by is totally up to you.

2. Investments and assets

Another quarter of respondents said they would use investments or assets to pay off their interest-only mortgages.

People might be planning to use profits from investments, savings, or inheritance.

Some interest-only mortgages come with endowment policies - these are investment products that pay a lump sum on maturity.

If you don't already have any of these things, and your mortgage term ends soon, it'll be too late to take this approach.

3. Remortgaging

One in six customers said they would remortgage to pay off their existing loans. The majority of these homeowners will opt for a capital repayment mortgage, meaning they will pay off interest and capital in monthly instalments, as is the case with most mortgage deals.

However, not everyone will be accepted for a repayment mortgage, especially if they entered into an interest-only mortgage deal because they could only afford the smaller monthly payments.

People in this situation risk becoming mortgage prisoners, often paying hundreds more in interest than they would be if they remortgaged.

Older customers might face this problem because many lenders will only offer mortgages to homeowners under 75-years old.

For these borrowers, a retirement interest-only (Rio) mortgage could help. These largely work in the same way as interest-only mortgages, but they're usually repayable through the sale of your home when you die or move into long-term care.

Some 4.5% of the customers we surveyed said they'd take out a Rio mortgage to repay their interest-only mortgage. Despite this, Rios are thought to be fairly unpopular; a This Is Money investigation found that only 660 had been sold since they launched last year.

4. Selling your home

The fourth most-popular method of settling an interest-only mortgage was moving out and selling.

If you can't remortgage and you don't have enough money to pay the bill, this might be your only choice.

Selling your home can be a long process, so if you do opt for this method, start early.

If your home's value has increased since you moved in, you may be able to use any profit as a deposit on buying another home.