Interest-only mortgages offer low initial payments but carry significant risks, primarily that you build no home equity during the interest-only period and face a severe "payment shock" when required to pay down the principal. If property values drop, borrowers risk owing more than the home is worth, making it difficult to refinance or sell.
The biggest drawback of an interest only mortgage is that you don't pay off the loan as you go. This means you have to find another way to do this – you can't just forget about it. Another downside of an interest-only mortgage is that the total amount you repay over time will be much higher than a repayment mortgage.
An interest-only mortgage offers a lower monthly payment at first and is best suited for people with ample assets, good credit and short-term ownership.
One major risk is that your monthly payments could increase significantly at the end of the interest-only period when you are required to start paying both principal and interest. Additionally, if your property's value decreases, you could find yourself underwater on your loan — owing more than the property is worth.
Lenders have shied away from interest only mortgages because history indicated that people were perhaps less than willing to give up that extra money to invest, or perhaps they were bad at managing investments and didn't generate the required returns. Interest only mortgages increase the risk for the lender.
What are the benefits of interest-only mortgages? Some people like the flexibility to be able to make lower payments initially, and pay more when their income or savings increase near the end of their mortgage term.
With interest-only mortgages, you only pay off the interest on the amount you borrow. You use savings, investments or other assets you have (known as 'repayment plans') to pay off the total amount borrowed at the end of your mortgage term.
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You can pay off your interest only mortgage early, but there may be limitations to the amount you can repay without incurring an Early Repayment Charge (ERC), depending on your mortgage. Check your mortgage terms for more information on repayments limits or charges.
Interest-only mortgages make up 9% of the total number of regulated mortgages, and part-and-part mortgages make up 3%. The remaining 88% are capital and interest mortgages. The peak years when the largest number of interest-only mortgages are due to mature are 2031 and 2032, with a smaller peak around 2027.
If you intend to invest and sell before the loan term ends, interest-only might be useful for you. On the other hand, if you're buying a family home for the long term, principal-and-interest repayments might serve you better.
An interest-only mortgage payment on $200,000 depends on the interest rate, but at 5%, it's around $833/month (just interest), significantly lower than principal & interest payments, though you never build equity and pay more total interest over time, with later payments including principal. For example, at 3.25%, the initial payment is about $542/month for the interest-only period.
If an interest-only mortgage doesn't sound right for you, here are some other options: Conforming conventional loans. This is the most common loan type in the United States. It has a maximum loan amount and typically costs less than a Federal Housing Administration loan but has stricter eligibility requirements.
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If your mortgage term ends before your mortgage is paid. Speak to your lender right away if you cannot repay the capital sum that you owe. You can ask them to work with you on a repayment plan. Your lender cannot ask for the money back until your mortgage term ends.
As the monthly payments on interest-only mortgages cover just the interest owed, they can often be hundreds of pounds cheaper than those for a repayment mortgage for the same amount.
Overpayments on interest only parts of your mortgage won't automatically reduce your monthly mortgage payment, unless you ask us to, but could save you money by reducing the amount of interest charged.
Short-term savings: Renting is cheaper than buying in the short term because you don't need a big down payment or lump sum to buy a house. Moving flexibility: You have much more flexibility with changing your home and moving around. This is great for individuals not set on living in the same place for years to come.