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Interest Only Mortgages - Repayment Vehicles

The key information you need to know about interest only mortgage repayment vehicles.

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By Pete Mugleston  | Mortgage Advisor Pete has been a mortgage advisor for over 10 years, and is regularly cited in both trade and national press.

Updated: 23rd August 2019 *

We get lots of people asking us about interest-only mortgages. They can be a viable option if you’re keen to get on the housing ladder, you have a deposit, but are worried about managing the monthly repayments.

The good news is that the brokers we work with are experts when it comes to interest-only mortgages and can help you find the best deal for your needs and circumstances.

In this guide we’ll look at:

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What is an interest-only mortgage repayment vehicle?

Simply put, it’s a means of paying off your mortgage debt at the end of the term.

With interest-only residential mortgages, the borrower is only obliged to pay off the interest each month, and the full loan amount is due at the end of the term, and this is where your repayment vehicle comes in.

Most interest only mortgage lenders will want you to evidence a viable repayment vehicle in advance before they provide you with a home loan.

What is classed as an acceptable repayment vehicle will vary from one mortgage provider to the next. Read on for more information.

Can I get an interest only mortgage without a repayment vehicle?

Not usually. Most reputable lenders will want to know how you will repay the loan amount at the end of the term, so unfortunately, it’s not possible to get an interest only mortgage with no repayment vehicle in place.

The exception is if you’re purchasing a buy-to-let property. Most buy-to-let mortgages are offered on an interest-only basis and assessed on the viability of the investment.

What is the best repayment vehicle for interest only mortgage?

This will ultimately depend on which lender you approach as well as your personal circumstances, but first, some background...

Following the FCA’s review of interest-only mortgages in 2013, a new set of lending rules were introduced as part of the 2014 Mortgage Market Review- essentially, an attempt to prevent the irresponsible lending practices of the pre-crisis years. 

These rules require prospective interest-only borrowers to provide evidence of repayment plans to lenders and to take full responsibility for the investment strategies (or payment vehicles) which will ultimately repay the loan (or risk having to sell the property to make up the shortfall). 

As we’ve already touched on, suitable repayment strategies can also vary from lender to lender but typically include…

  • Savings accounts and ISAs
  • Stocks and shares
  • Investment bonds and unit trusts
  • Pensions
  • The sale of the property

Read on to find out how these repayment vehicles work or make an enquiry and one of the whole-of-market brokers we work with will go through them with you.

Savings accounts and ISAs

Some lenders will no longer accept savings in Individual Savings Accounts (ISAs) or current accounts as a sole repayment vehicle when assessing an interest only mortgage repayment plan, although it will may be possible for borrowers to plough these funds into one of the investment schemes detailed below. 

Customers looking at the best savings plan for an interest only mortgage will need to make sure that they have calculated the likely rate of return (according to a range of varying interest rates) or level of risk on each option in advance of application and to factor in the impact of a ‘worst case scenario’.

Stocks and shares or stocks and shares ISAs

Borrowers will need to provide evidence of share certificates, account statements or confirmation by a broker of current holdings and valuations in order for this to qualify as an interest only mortgage repayment vehicle. Some lenders will accept up to 80% of the latest annual valuation on (variable) asset amounts as part of their assessment of acceptable values (or the amount needed to cover the mortgage).

Other lenders base their assessments on projections of mid-term values and others accepting 50% of current values with no growth projections. 

Investment bonds and unit trusts

As above, necessary documentation will be needed for bonds and trusts to be used as an interest only mortgage investment vehicle.

Using an endowment policy to pay off an interest only mortgage

In the past many borrowers used an endowment policy to pay off their interest only mortgage. With short-falls on returns and high commission fees leading many holders to cash in on policies or sell them via second-hand markets, endowment policies for interest only mortgages have become less and less common over the last few years. 

Nevertheless, they still exist, and most lenders will accept the middle (or median) figure provided by endowment companies (based on projections of three growth rates).

Using a pension as an interest only mortgage repayment vehicle

Borrowers aged 55 or over could consider using their pension as an interest only mortgage repayment vehicle, with 25% of the overall value allowed to be withdrawn tax free under new rules introduced in 2015 (although withdrawals above this amount are taxed as income). 

However, as with all the payment options covered in this section, different lenders vary as to the amounts that they will accept to support a mortgage application, with some imposing a maximum percentage (of between 15% and 50%) on projection values. 

Moreover, it’s worth bearing in mind that pension amounts will need to be considerable if the borrower wishes to cover the debt balance from their 25% tax free lump sum (with £600-800,000 needed on mortgages of £150-200,000) and could obviously prejudice an ability to support themselves in retirement.

Repaying an interest only mortgage by selling the house

Another option for borrowers to repay an interest only mortgage is by selling the house.

Homeowners can downsize to a smaller property and use the extra equity which has (hopefully) built up on the primary (or mortgaged) property to pay off the balance on their interest-only mortgage. 

Most lenders will impose a minimum equity value from these sales (usually of between £100,000 and £250,000) to downsize and will require evidence to support the plans; they will also need to be notified in advance if this option is to be used to support an application. 

Sales on secondary properties may also be accepted, although most lenders will insist that projected valuations are subjected to ‘haircuts’ (or deductions) of around 30% to ensure that amounts achieved at sale are sufficient to cover the mortgage (especially at a time of lowering house prices or economic stress). 

However, with fluctuating house prices offering little in the way of guarantees on projected returns, borrowers will need to be wary of pursuing this course of action as they could face having insufficient funds to buy another property, or even negative equity, once the mortgage debt is repaid. 

As a result, some mortgage providers will refuse to lend on this basis or will demand evidence of additional income or assets to support the application before accepting a borrower will clean an interest only mortgage with the sale of property.

How to get out of an interest only mortgage

Some borrowers find that one of their investment plans is underperforming or that they are unable to repay their loan in full and as such we hear lots of questions along the lines of “how do I get out of an interest only mortgage?”

There are a few possible solutions for those wondering how to get off an interest only mortgage...

Switch to a part and part mortgage

Borrowers could choose to switch a part of their mortgage to a repayment deal, meaning that some of their monthly payment will go towards paying off the mortgage balance and some will go towards the interest. 

The advantage here is that the balance will decrease every month, leaving less to pay at the end of the mortgage term (although monthly repayment amounts will also go up, sometimes considerably, to reflect this ‘split’). 

Nevertheless, with lenders under increasing pressure to ensure that these types of loan are paid on time and in full, borrowers who remain with their current provider may be able to extend the terms of their mortgage and pay off the debt over a longer period (though, in some cases, they may be charged higher rates). 

For more information on part and part mortgages section.

Remortgage onto repayment

Alternatively, if you don’t have an interest only mortgage repayment vehicle borrowers could go the whole hog and remortgage onto a repayment deal at a lower rate, thereby extending the terms of their loan and inviting the possibility of using the money that would have previously gone towards servicing interest costs to pay off their capital debt.

However, by changing lenders, borrowers will be required to undergo a full affordability assessment and to show evidence of a repayment plan, potentially damaging the chances of being accepted for those who took out interest-only mortgages before the 26th of April 2014 (when the new FCA lending rules came into effect). 

Moreover, for borrowers who are rejected or who choose to remain with their current lenders, the substantial increases in monthly repayment rates (as well as the possibility of higher rates) could prove to be beyond their financial capabilities.

Equity release

Borrowers who are aged 55 or above could also consider switching their loan to an equity release-based ‘lifetime mortgage’ once their interest-only mortgage is due. 

This is a type of loan which involves borrowing against the value of a property. Interest amounts on these mortgages are typically ‘rolled up’ onto the existing capital debt, meaning that borrowers are not required to make any type of payment (either monthly or otherwise) until they die or go into long-term care (at which point the debt is settled, invariably from the sale of the property). 

However, rates on compound interest amounts are extremely high, potentially increasing the underlying debt by as much as double, treble or even quadruple over a 15, 20 or 25-year period (depending on how long the borrower lives for)- leaving little or nothing to bequeath to children or grandchildren. 

In other words, even if the borrower is eligible for such a loan, they should think long and hard before they decide to pursue it.

If all else fails, borrowers may need to sell their existing property and downsize in order to pay off their loan, access a later life interest-free mortgage or even consider renting; a less than palatable option, of course, but one which emphasises just how important it is to maintain a robust repayment plan.

Obviously releasing equity from a property should never be done lightly, but the good news is that the advisors we work with are always on hand to offer their insight and help you determine whether this is the best option for you and find you the right lender. Getting the right advice is key - make an enquiry and we’ll introduce you to an equity release expert.

Speak to an interest only repayment vehicles expert today

If you have questions and want to speak to an expert for the right advice, call Online Mortgage Advisor today on 0808 189 2301 or make an enquiry

Then sit back and let us do all the hard work in finding the broker with the right expertise for your circumstances.  We don’t charge a fee and there’s absolutely no obligation or marks on your credit rating.

Updated: 23rd August 2019
OnlineMortgageAdvisor 2019 ©

FCA disclaimer

*Based on our research, the content contained in this article is accurate as of most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information. The info on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs. Some types of buy to let mortgages are not regulated by the FCA. Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.

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Interest Only Mortgages