How does an interest-only mortgage work?

How does an interest-only mortgage work?

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If you are looking for a new home or an owner-occupied home, you probably need a mortgage. A type mortgage to consider is an interest-only mortgage. Here’s how an interest-only mortgage works and why it is different from an interest-only mortgage.

What is an interest-only mortgage?

With an interest-only mortgage, you only pay the loan interest each month. You only pay back what you have borrowed when the term of the mortgage ends (for example in 25 years).

What makes this different from a redemption mortgage? Well, the clue is in the name. If you get a repayment mortgage, you repay the loan monthly plus interest. So you pay more each month, but once the loan matures, you own the property unless you default on the way.

How does an interest-only mortgage work?

Essentially, the amount you owe remains the same over the life of the mortgage. Think of it this way: You pay the interest so that the amount you owe doesn’t increase, but it doesn’t decrease either.

  • If you take out an interest-only mortgage for £ 150,000 over 20 years, you will still owe £ 150,000 when the term is up. You do not own the property until you pay this money.
  • If you go for a repayment mortgage, you owe nothing. In 20 years, the house will be yours.

It is easy to calculate your monthly payments. Just look at the interest you pay on the total amount. For example, if you borrow £ 150,000 on a 3% mortgage, you owe £ 4,500 in annual interest. Over 12 months, this works out to £ 375 per month.

Interest-only mortgages can be more expensive over time than amortization mortgages, but they can be more convenient because the actual monthly costs are lower. However, remember how an interest-only mortgage works: you still have to pay the lump sum at the end!

What happens when the loan period ends?

At the end of an interest-only mortgage term, there are three ways in which you can pay off the loan:

  • Sell ​​the property. However, there is always a risk that your home will decline in value over time, requiring additional capital to cover the deficit.
  • Remort the property and turn it into a repayment mortgage. However, you still have to meet your lender’s criteria to offer a new mortgage, so there is no guarantee that you will be able to do this.
  • Use savings, ISAs or investments to cover the balance. Again, there is no guarantee that you will have enough money by the time the loan balance falls to cover the payment.

It may be worth talking to a financial advisor for more advice on your options for paying off the home loan.

Who can get an interest-only mortgage?

Nothing prevents you from applying for an interest-only mortgage. If you meet the lender’s specific criteria, you can be approved. In general, however, you are more likely to get such a mortgage if you:

  • already have a big one deposit;
  • have sufficient equity in another real estate; or
  • earn a high salary.

Essentially, it’s about showing that you can afford to pay back the loan when the term expires. The more capital you have, the less ‘risky’ lenders think you are. So if you are a new buyer, you will likely find it more difficult to get an interest-only mortgage unless you have significant capital elsewhere.

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Take out

So we’ve discussed how an interest-only mortgage works, but is it right for you? It depends. Although your monthly payments are cheaper, you still have to pay back the loan at the end of the term.

Some people prefer to pay more each month knowing they will own the home once the term of the mortgage ends. it all comes down to your personal circumstances.

Apply for an interest-only mortgage? Directly approach a lender or use a mortgage broker. Remember, you need to show that you can afford the monthly repayments, so make sure you use it Bank statements or proof of income ready. It might be worth it checking your credit report and creditworthiness before signing up.

Not sure if an interest-only mortgage is right for you? Consider dealing with a FCA registered financial advisor before applying.

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