Interest-Only Remortgage
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Interest-Only Remortgage
Steven Hargreaves explains how an interest-only remortgage works.
What is an interest-only remortgage?
An interest-only mortgage is where you’re just purely paying the interest, and you’re not paying any capital back. If you borrow £100,000 on an interest-only mortgage over five years, five years later, you haven’t paid any capital off. The amount that you borrowed hasn’t reduced, as you’ve only been paying the interest – so you still owe £100,000.How does an interest-only remortgage differ from other types of remortgages?
I’ve got a client doing a remortgage at the moment. It’s quite a small mortgage against the value of the property. They bought a four-bedroom house that was quite cheap. They’ve added considerable value to that property, but they now realise it’s probably too big for them and they plan to sell that house in two to three years. If they take a repayment mortgage, in three years they won’t have paid a lot of the capital back, and the monthly repayments on that mortgage are high. They’ve decided to take an interest-only mortgage, as it means the monthly payments are considerably lower. At the end of the two or three years, they will sell the house to pay off that mortgage, and buy something a bit smaller.Who is eligible for an interest-only remortgage?
Each lender is slightly different in how they look at interest-only mortgages, and some don’t offer them at all. You may need a certain amount of equity in the house – typically 20% or 25% equity. Other lenders base it on the equity as a figure. They might insist on a minimum of £250,000 in equity. It certainly isn’t for somebody who owns a house worth £100,000 and has a £95,000 mortgage. In that situation, a lender would put you on a capital repayment mortgage.What are the benefits of an interest-only remortgage? What are the drawbacks or risks?
The benefits are that on an interest-only mortgage, the payments are considerably cheaper. The disadvantage is that you’re not paying any capital back. Many years ago there were Diamond mortgages or ISA mortgages which were effectively investment-backed. You would take an investment vehicle and an interest-only mortgage, and the idea was that the investment – perhaps an endowment or an ISA – would pay off the interest-only mortgage at the end of the term. 20 years ago, these were the most popular mortgages, but they weren’t sold as ethically as you might hope. The investments didn’t do quite as well as they could, and some people ended up facing a shortfall. That’s why most people these days prefer a repayment mortgage over an interest-only mortgage. But rest assured, interest-only is brilliant for the right client.How does the application process differ for an interest-only remortgage?
The only difference is that you’ve got to prove how you will repay that capital. A lender wouldn’t accept you without an exit plan. In some cases, that will be the sale of the property. Or, you may have other, unencumbered properties like a Buy to Let or an investment property. You might have an ISA or an endowment that you’re paying into with the intention of paying the mortgage off. The application process isn’t necessarily any different – you just have to confirm how you will pay the capital back to the lender.Speak To An Expert
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What are the repayment options for an interest-only remortgage?
One that a lot of people use is the sale of that property. If you live in a big five-bedroom house, at some stage your children will move out and you’ll want to downsize to something smaller.
If that house was worth £500,000 and you had a £100,000 mortgage on it, on an interest-only deal you wouldn’t reduce that £100,000 owed. But when you’re ready to sell, hopefully the house at that stage might be worth £600,000 or £700,000.
You sell the property, pay the £100,000 off, and use the equity to buy something outright.
What happens when the interest-only period ends?
That’s when the lender will want the money back. If you’ve taken an interest-only mortgage over 20 years, at the end of that term you need to repay the mortgage in full. You might sell the property, sell another property or you will have an investment vehicle ready to pay it back. You do need to have that exit strategy in place – that’s essential.
What should borrowers consider before taking out an interest-only remortgage?
It’s all about your attitude to risk. If you take a repayment mortgage out, you’re paying the capital and the interest. On a 20-year mortgage, at the end you’ve paid the interest and the capital off. There’s zero outstanding.
If you’ve taken an interest-only mortgage, you need a way to pay that mortgage off at the end of the 20 years. You need to sell another property or have another exit ready. You need to consider that very carefully before you commit to an interest-only mortgage.
Are there any alternatives to an interest-only remortgage?
Yes – a straightforward repayment mortgage. You could also take a part-and-part mortgage. I’m looking at this for a client who wants part interest-only and part on capital repayment. They are due quite a large inheritance in a few years’ time.
They can’t afford a full repayment mortgage, but they can afford to have a proportion of it on repayment. In the next five years, they will inherit a lump sum of money which will pay a lot of the mortgage off – and certainly the interest-only element.
They didn’t feel comfortable enough going fully interest-only; and they can afford a part-repayment approach.
We’ve covered the main questions – anything else you’d like to add or final thoughts?
A good mortgage broker will talk you through the options. We won’t just sell the positives – we explain the negatives. As long as you fully understand it, interest-only can be a fantastic mortgage option – but it’s always specific to a client’s requirements.
Key Takeaways:
- An interest-only remortgage involves only paying the interest, which makes the monthly payments considerably cheaper, but the original borrowed capital is not reduced over the term.
- A crucial requirement for application is proving a robust exit plan to the lender for how the full capital amount will be repaid when the interest-only period ends.
- Lender eligibility often requires the borrower to have a certain amount of equity in the property, typically 20% to 25%, or a minimum specified equity amount.
- Common exit strategies for repaying the capital include selling the mortgaged property, selling other unencumbered properties (like Buy to Let), or relying on investment vehicles such as ISAs or endowments.
- The interest-only approach is best suited for the right client and requires careful consideration of their attitude to risk, with alternatives including a straightforward full repayment mortgage or a part-and-part option.
THINK CAREFULLY BEFORE SECURING OTHER DEBTS AGAINST YOUR HOME.
YOU MAY HAVE TO PAY AN EARLY REPAYMENT CHARGE TO YOUR EXISTING LENDER IF YOU REMORTGAGE.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.
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