Interest Only Mortgages

This type of mortgage is different to all the other forms in that the monthly repayments cover only the interest charges on the borrowed amount - there are no provisions built into an interest only mortgage to repay the principal. As the mortgage isn't repaid over its term, the borrower needs to make other arrangements to raise the money needed to clear the debt once the end of the mortgage period is reached.

The major benefit of this approach is that it means the monthly payments are minimal, much less than they would be on a repayment type of mortgage. As such, interest only mortgages are popular with those who perhaps would struggle to cope with repayments, but who could afford to meet the interest costs and are confident that their earnings will increase in the future to allow them to make the full repayment fifteen or twenty years down the line, first time buyers usually fit into this category.

Repaying the amount borrowed is something that has to be planned for by the borrower, as at the end of the life of the mortgage the amount owed will be the same as when the mortgage was arranged. There are a number of options when it comes to this, including paying into a savings account regularly, setting up an ISA (Individual Savings Account) to save in a more tax efficient manner, switching the mortgage to an endowment or repayment type further down the line or even selling the home at the end in order to clear the mortgage with the proceeds.

A common approach with interest only mortgages is for the person to opt for this form to begin with, in order to benefit from the minimal monthly payments while starting out and money is perhaps a bit tight, and then switch over say five to ten years later to some form of repayment mortgage.

There are a number of benefits and drawbacks associated with interest only mortgages, let's start with some of the negatives. Firstly there is the added complication to the borrower of arranging some means to ensure that they have the necessary money to repay the debt at the end of the term. If this is to be taken care of through some form of savings scheme, then it will also require monitoring as a shortfall could occur and cause problems.

Cost is perhaps the biggest drawback associated with such a mortgage, while the monthly payments are minimal, making the mortgage affordable purely in the sense of immediate cost, the interest charged and circumstances mean that long-term the costs can be higher than for other forms. One reason for this is that the debt on which the interest is calculated remains the same throughout, whereas repayment mortgages see this amount fall and so the interest charges fall with it. This can of course be offset by some degree by savings that are intended to repay the mortgage, however the interest earned on these will always be less than that charged on the debt, and those earnings will be taxable.

There are positives, the main one is that by making the monthly payments only cover the interest on the borrowed amount, it opens up the level of mortgage that is affordable - if a repayment mortgage is just out of reach, then an interest only one can provide a viable option.