At the end of an interest-only mortgage, borrowers must repay the entire loan amount. Options include paying a lump sum, selling the property, remortgaging, or arranging extended repayment with the lender. Planning is crucial to avoid financial challenges and potential property repossession.
At the end of the interest-only period, the loan will change to a 'principal and interest' loan. You'll start repaying the amount borrowed, as well as interest on that amount. That means higher repayments.
Interest-only mortgages offer attractive benefits, such as lower monthly payments and increased cash flow for investments. However, they also come with significant risks, including the need for a large lump-sum payment at the end of the term and limited availability.
At the end of the interest only period, borrowers will begin monthly principal and interest payments until the full balance of the loan is paid in full. The length of time you can make your payments interest only depends on your lender and loan terms, but typically ranges from five to 10 years.
When this interest-only period ends, your monthly payment amount will raise substantially with the inclusion of both principal and interest payments. Additionally, if the interest-only loan is also an ARM, the payment amount may also fluctuate due to the periodic interest rate changes.
Cons of interest-only loans
Higher interest rates: Interest-only loans typically come with higher interest rates compared to fully amortizing mortgages. Lenders consider these loans riskier due to the lack of principal reduction during the interest-only period.
Once your mortgage term is over, you'll still owe the lender the same amount you initially borrowed – so you'll need to either pay it back or remortgage your home.
A typical interest only mortgage lasts between five and 25 years. It's possible to remortgage to a new deal at any time, which is often a good idea if interest rates have changed. You can also remortgage at the end of the deal – but you will need to meet affordability criteria.
After the interest-only period, you have the option to refinance, pay a lump sum, or begin paying down the principal. However, it's important to note that your monthly payments will increase significantly once you start paying both the principal and the interest.
Advantages of an interest-only mortgage
Lower monthly payments, as you are only paying back the interest on your loan. Greater control over your investments, meaning you can decide how you save to repay the capital of your mortgage.
In some cases, your lender can extend your interest only period over the phone, via your mortgage broker or by you filling in a form. They don't need to reassess your full situation. However, if you don't meet certain bank criteria then you'll need to submit a full application for the bank to assess.
The main reason people choose interest-only mortgages is to reduce the amount they have to pay out every month. If you can afford the monthly payments on a repayment mortgage, that is usually the better choice.
Yes; offset accounts can be linked to interest only loans. By keeping funds in an offset account, you can benefit from reduced interest expenses while enjoying lower monthly repayments during the interest only period.
It is possible to ask lender to extend your term to give you longer to save for the lump sum. This could give you the chance to switch at least some or all of the loan to a repayment mortgage, as by extending the term, your monthly repayments will be lower and more affordable.
If you cannot pay off your mortgage when the term ends, then you can ask your lender to extend it. This will likely involve an affordability assessment but will give you several extra years to pay off the remaining amount. Remortgage. Look into finding a new deal with a different lender.
👎 Drawbacks of Interest-Only Mortgages
With interest-only, you're only paying to borrow, not own. So, unless the market adds value to your home, you won't be building any equity. If prices drop, you could even end up owing more than your home's worth – a bit like paying rent but with a big bill waiting at the end!
Yes. Some mortgage lenders will consider a straightforward remortgage on the same interest-only terms. In many cases, your existing lender will be prepared to offer you a new deal. But it's important to check the rest of the market, too, as there may be a better deal available by switching lenders.
If you have an interest only mortgage – or part of it is interest only – you can change to a capital repayment mortgage. That means you'll start to pay off the capital you've borrowed as well as the interest. If you move your whole mortgage to capital repayment you will have paid it off in full by the end of the term.
In contrast, with an interest-only mortgage, your overpayment will typically only be used to reduce future interest payments or the overall interest you pay. So, while it could still be a good idea to save some money, overpaying won't usually increase the equity you hold in your property.
Once a mortgage term has ended, any outstanding balance is due immediately. This can leave the homeowner with limited options: sell, remortgage, or face possession action in the courts.
Benefits of an interest-only mortgage
The most obvious benefit of an interest-only mortgage is that monthly payments are initially considerably lower than of typical loans. These loans allow the borrower to make larger purchases that they would otherwise only be able to afford a few years down.
If you have an interest-only mortgage, you need to make plans to repay the capital (the amount you borrowed). If you don't, you will have a large amount to pay at the end of your mortgage term and may need to sell your home to repay it. You might be either unable or unsure of how to change your plans at the moment.
If you want to make principal payments during the interest-only period, you can, but that's not a requirement of the loan. You'll usually see interest-only loans structured as 3/1, 5/1, 7/1, or 10/1 adjustable-rate mortgages (ARMs).