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At first glance, straight-rate mortgages may seem like an attractive option for homebuyers who don’t want to commit to heavy monthly repayments. An interest-only mortgage is a mortgage contract where the borrower pays “interest only†each month rather than having it on a principal and repayment basis.
The payments are less than a amortization mortgage, but at the end of the term, the homeowner still owes the original loan amount from the lender. The majority of employees prefer to pay a fixed monthly fee, gradually reduce their debts and at the same time create equity in the property. This mainstream approach is not for everyone, however, and lenders are increasingly open to only considering interest-bearing mortgages if there is a reason to.
As with any large financial commitment, it is important for prospective buyers to seek expert advice to ensure that an interest-only mortgage is appropriate for their individual circumstances.
There’s no hard and fast rule when it comes to eligibility, but interest rate mortgages are generally not suitable for first-time buyers who are often and slowly taking out high loan-to-value (LTV) loans to create equity in the property safely reduce the debt.
Of course, there are exceptional circumstances under which a first-time buyer might be considered for an interest-only mortgage. Perhaps if you are self-employed and receive an annual dividend, have a high net worth or have the option of paying high installments at structured intervals. But these cases are rare.
What does a solid repayment plan look like? Anyone who opts for a purely interest-bearing mortgage needs a structured repayment strategy.
You should ask yourself these questions: How do I pay back the capital I originally raised at the end of the mortgage contract? How can I achieve debt reduction during the agreed term?
Repayment strategies can come in many different shapes and sizes, from investment plans to freeing up equity in additional real estate to making one-off payments from an annuity. And while most lenders require proof of a solid settlement plan, some may accept the sale of the mortgaged property or a reduction as their main amortization tool. However, should borrowers take this route, there are some very clear guidelines, including:
Annual income. Lenders see this only as a viable option for those earning between £ 75,000 and £ 100,000 a year, so borrowers do not choose the interest-only route for cash flow purposes, but rather because it is the best strategy for them.
Equity: Depending on the location, the borrower must have a certain amount of equity in his own home, especially if a reduction is to be possible. Realistically, the homeowner would need to have built up at least £ 250,000 in equity to ensure the affordability of a smaller property.
If prospective buyers cannot afford a repayment mortgage, they are likely to stretch too far, especially in the current climate when interest rates are so low.
If the borrower has the funds, the possibilities could be endless. However, if there is no amortization schedule in place, the chance of an interest-only mortgage is very limited.
* Andrew Milnes is the General Manager at Mortgage Advice Bureau, Bingley. Contact: 01274 568832
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