Mortgages. Interest only mortgages back in fashion

Interest only mortgages fell out of favour a few years ago but it looks like they’re coming back – with a vengeance! Back in the first quarter of 2002, interest only mortgages were not a popular option, with fewer than 10 deciding to take them out. In the last three months of 2005, figures were a lot higher, with almost a quarter of new mortgages being interest only. A considerable amount of these borrowers are first time buyers, rising from 6 in 2002 to 15 in the 2005 figures. The reason is quite simple – getting an interest only mortgage is the perfect way to afford the monthly repayments without sacrificing lifestyle. Since most people are forced to buy homes that are slightly out of their price range, a repayment mortgage can be too much to deal with, so interest only is the easy way out. The way the interest only mortgage works means that you pay off the interest as you go, and then pay the capital sum off at the end of the term. Borrowers are supposed to set up a separate savings vehicle to cover this eventual repayment. The problem is, some people don’t bother, and decide to cover the repayment by selling the property at the end of the term and downsizing – something that both the FSA and lenders are anxious to avoid, especially as the economy cannot be depended on over such a long period of time. Their concerns have led to some changes in the way interest only mortgages are administered. Before, borrowers could get the mortgage quite easily without having to provide any proof of a separate savings vehicle. Now, they must provide that proof before the mortgage can be arranged. Most people choose to save with an ISA or pension because they are tax free and will ideally over-perform – leaving the borrower with an extra nest egg at the end. There’s nothing to stop borrowers from setting up a savings vehicle, however, and then simply deciding not to use it, or even cancelling it straight away.Interest only mortgages used to be the most popular way of paying back a mortgage, and an endowment policy would be the savings vehicle. But you’ll have heard in the last few years that many of these policies under-performed, and people were left with a shortfall when the time came to pay off the capital. Thanks to all this publicity, the interest only mortgage completely fell out of favour. Like all investment products, they could not be relied on 100 to perform as expected. Similarly, no investment product taken out now can be 100 relied on to perform well and provide the projected sum in 25 years time. So now the majority of people do go for the repayment mortgage – there’s no uncertainty there, and there is no chance of falling short at the end of the term as you pay as you go. But it would seem that people are starting to consider their options again, but it probably isn’t because they want to see how well they can do with a separate savings vehicle. We think it’s simply because they can’t afford the repayment mortgage, or are not prepared to undergo a radical lifestyle change in order to be able to afford it – and that’s not the right reason to choose interest only.There are other options, and lenders should be advising homebuyers of these options rather than arranging the interest only without further discussion. For example, a mortgage can be over 30 or 35 years, it doesn’t have to be over 25. That will help make the repayments a lot more affordable, Take a mortgage for £125,000 as an example. At 4.9 the monthly payments will be £731.69 if taken over 25 years. The payment will be reduced to £628.16 if taken over 35 years – a real help when money is an issue. And there’s no reason why you can’t remortgage once you feel ready to up the payments. There’s also the option of overpaying with most repayment mortgages, within certain boundaries at the outset.Another option is to take out a mortgage where you repay half of the capital as you go, and the other half at the end, which lowers the monthly repayments considerably. The bottom line is – don’t try and make these decisions on your own. They’re way too important and there are too many choices to make. Talk to an independent mortgage adviser and make the most of their experience, they’ll get you the best deal too!

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