Mortgages The Pitfall Of Interest Only Mortgages

Mortgages The Pitfall Of Interest Only Mortgages

Mortgages .​
The Pitfall Of Interest Only Mortgages.
In the​ first three months of​ 2002,​ just 9% of​ all new mortgages were taken as​ interest only - but by the​ last quarter of​ 2018,​ the​ figure had risen to​ 23% .​
And amongst first time buyers,​ the​ figures rose from 6% to​ 15% .​
(Source: Council of​ Mortgage Lenders.)
The reason is​ obvious .​
It's down to​ family economics .​
With an​ interest only mortgage,​ the​ monthly repayments only repay the​ ongoing interest so your monthly repayment is​ low .​
Repayment of​ the​ capital borrowed is​ delayed to​ the​ end of​ the​ mortgage when it​ has to​ be repaid as​ a​ lump sum.
So the​ popularity of​ interest only mortgages is​ a​ reflection of​ borrowers wanting to​ minimise their fixed monthly outgoings in​ order to​ preserve their lifestyle – they still want their nice cars,​ nights out and holidays abroad .​
But their reluctance to​ cut back on​ their life style spending,​ combined with steadily rising house prices,​ could be storing up problems for the​ future .​
If they're not repaying some of​ the​ capital now,​ how are they going to​ repay it?
Egged on​ by the​ concerns voiced by the​ Financial Services Authority (FSA),​ many lenders are now becoming much stricter when assessing an​ application for an​ interest only mortgage .​
They're insisting that there's a​ viable repayment vehicle in​ place before they'll payout the​ money .​
These repayment vehicles could be the​ tax-free cash forecast from a​ pension policy,​ or​ an​ ISA or​ some other regular investment or​ savings scheme .​
The danger is​ that having got the​ mortgage,​ the​ borrower subsequently cancels their savings scheme.
If that were to​ happen,​ when retirement finally arrives accompanied by the​ looming commitment to​ repay the​ mortgage capital,​ they'll be faced with having to​ sell their home and down size simply to​ free up money to​ repay the​ mortgage .​
And that's a​ scenario that lenders and the​ FSA are anxious to​ avoid.
Twenty years ago interest only mortgages were the​ accepted norm with endowment policies being used as​ the​ most popular investment to​ repay the​ capital .​
But as​ we now know,​ returns on​ endowment policies have not been as​ high as​ many had assumed .​
This has left thousands of​ homeowners with a​ capital repayment shortfall .​
Endowment policies have certainly failed to​ be the​ guaranteed repayment solution that many of​ us had assumed twenty years ago .​
So,​ in​ today's economic and investment environment,​ how certain can you​ be of​ any scheme to​ repay the​ capital?
When the​ shortcomings of​ endowment policies slowly became understood,​ interest only mortgages fell out of​ favour and repayment mortgages took over as​ the​ norm .​
But once again the​ pendulum is​ swinging .​
Interest only mortgages are back in​ a​ big way .​
It's the​ result of​ high house prices and people straining to​ get onto and up the​ housing ladder without wanting to​ economise on​ other areas of​ their spending.
We're sure that the​ pressures within family finances will continue to​ fuel the​ demand for interest only mortgages .​
However,​ it​ becomes the​ duty of​ mortgage brokers and the​ lenders to​ point out the​ alternatives open to​ their clients.
In the​ past,​ a​ 25 year mortgage term has been the​ norm for a​ young buyer .​
But now they can stretch the​ repayment period to​ 30,​ even 35 years .​
This makes the​ payments on​ a​ repayment mortgage far more affordable.
For example,​ the​ monthly repayments for a​ £125,​000 repayment mortgage over 25 years at​ say,​ 4.9% cost £731.69 per month,​ but if​ the​ repayment period was stretched to​ 35 years,​ the​ repayment drops to​ £628.16 per month,​ a​ cash flow saving of​ £103.53.
The idea is​ that as​ and when family finances permit,​ borrowers can reduce the​ capital outstanding by making optional lump sum repayments .​
In practice,​ people tend to​ move house every eight to​ ten years and at​ each move a​ new mortgage has to​ be organised .​
These moves then represent an​ obvious opportunity to​ reassess long-term family finances.
But other solutions are available .​
You could arrange a​ mortgage where part of​ the​ loan is​ on​ a​ repayment basis with the​ balance on​ interest only .​
It's a​ mid way option .​
At least these types of​ mortgage start the​ repayment process and later when you​ move home or​ the​ family income builds,​ you​ can take the​ opportunity to​ reassess the​ most suitable type of​ mortgage.
But please bear in​ mind that you​ shouldn't speculate when it​ comes to​ your home finances .​
Mortgages are complicated and there is​ never just one solution .​
Our advice is​ take professional advice and use a​ mortgage broker who can search the​ entire market.

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