A guide to interest-only-mortgages

As the name suggests, with an interest-only-mortgage the property owner makes monthly repayments, which only consist of this element of debt.

Pros and Cons

There are obvious advantages and disadvantages to this type of mortgage. On the upside, the monthly repayments are lower than standard mortgages, as no capital debt is being paid off.

On the downside, at the end of the mortgage term the homeowner will actually be no closer to owning the property. In that sense, an interest-free-property can be viewed as a type of rent – the landlord is your bank.

However, an interest-only-mortgage can be a good way for someone who can be sure that their finances are set to improve to buy some time and retain ownership of their property.

So is it a good idea?

Recent analysis by comparison website mform.co.uk revealed that 21 per cent of loans advanced in 2006 were on an interest-only basis. In January 2008 this figure had risen to 24.5 per cent.

According to Bernard Clarke of the Council of Mortgage Lenders (CML), interest-only-mortgages can be a "perfectly rational approach" to payment problems.

He said: "[It is fine] as long as the borrower is fully aware of the consequences and reappraises the need to put in place a plan for the repayment of the capital over the course of the loan."

First-time-buyers

Many first-time-buyers opt for interest-only-mortgages, as for young professionals who are in low-paying jobs but are confident their income will grow impressively, it can be a good way of getting a foot on the property ladder.

Andy Pratt, chief operations manager of independent mortgage advisory firm Alexander Hall, said: "It's not something that a good advisor would recommend. But it does depend on the circumstances."

He described the idea of an interest-only-mortgage as a "little bit of a cultural change".

"Instead of relying upon the lender to control the amount that they pay off on the loan, some feel quite knowledgeable and confident enough to pay the interest and control for themselves how much of the loan they pay off by doing it in lump sums every two or three years," he explained.

However, most financial experts agree that those who enter into this type of mortgage, should have a clear plan of how they will pay off the capital de back after.

Unfortunately, according to the CML the proportion of first-time buyers with an interest-only mortgage who did not specify how they planned to repay their mortgage has risen from six per cent in 2002 to 20 per cent in 2007.

Changes

According to financial website Moneyfacts over 10,000 mortgage products have been withdrawn by banks and building societies since the advent of the credit crunch.
In July 2007, a total of 15,599 deals were available to homebuyers compared with just 2008 5,785 in March.

Largely, it is higher-risk products such as interest-only-mortgages that are being hit, as banks and building societies become more wary over who they lend to.

As a result, the interest-only-mortgage may not be as freely available in the future.

31/03/2008

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