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Interest Only Residential Mortgages

Everything you need to know about interest only residential mortgages

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By Pete Mugleston   Mortgage Advisor

Last updated: 3rd December 2018

Interest only mortgages: what you need to know

We get lots of enquiries about this every week, from borrowers that either want to know more, or who may have found it difficult to get a residential interest only mortgage on a property. You may have been declined by lenders, or even given the wrong advice.

The good news is that the specialist advisors we work with can help advise you on how to obtain the right interest only residential mortgage for you.

Here’s what you’ll learn in this article:

Residential Interest only mortgages: what they are and how they work

As the name may suggest, an ‘interest only’ mortgage is one in which your monthly payments meet the interest on the balance of your mortgage. You don’t have to repay the full balance of the original loan until the end of the mortgage term, when it becomes due in a final, large sum.

This is in contrast to the more common 'repayment mortgage’ (sometimes referred to as a ‘capital repayment mortgage’), in which each monthly payment covers both the principle and the interest.

Interest only mortgage: The Pros

  • Your monthly payments are lower, as you’re only paying the interest, not the principle.
  • Inflation can reduce your debt. The £100,000 you borrow today may be worth less in real terms, 25 years later
  • Some interest only mortgages allow you to optionally overpay, which allows you to pay down the principle.

Interest only mortgage: The Cons

  • There’s no guarantee that you’ll have saved enough to pay off the principle at the end of the term, even if you sell the house you have a mortgage on.
    If you can’t pay it, there’s a chance you may lose the house, so it’s important to get the right advice from one of the expert advisors we work with from the word go.
  • Though many people choose to refinance an interest only mortgage to a repayment mortgage, it’s not always easy, especially if you are much older when you address the issue!

Repayment mortgage: The Pros

  • Your monthly payments count towards the interest and the principle, which means that later in the term, more of each payment goes towards paying off the principle.
  • Provided you make your payments, you don’t have to worry about having to repay a large sum at the end of your mortgage term.

Repayment mortgage: The Cons

  • You’ll pay a lot more every month and there are obvious opportunity costs associated with having more of your monthly budget tied up in your mortgage payments.
  • Often, very little of the capital is paid off in the early years of the mortgage - which means that if you remortgage very early, you have effectively taken out a more expensive, interest only mortgage.

Can I get a right to buy interest only mortgage?

There are some lenders who may consider an application for an interest only mortgage, assuming you have a high enough deposit or equity. As many right to buy homes are valued at 70% of market value, then the 30% equity may be acceptable as a deposit.

But be aware, like any residential interest only mortgage, you’ll need an exit strategy to pay the capital when it comes due.

Repayment Strategies for residential interest only mortgages

As the name may suggest, a ‘repayment strategy’ is the plan by which you’ll be able to pay the capital at the end of the loan period.

Most lenders will rightly require you to provide such a repayment strategy, which helps them (and you) be sure that you’ll be able to make the large final payment.

Lenders will accept a number of strategies, including:

  • The sale of the property you hold the mortgage on (only a few lenders would be happy with this as a repayment strategy)
  • Sale of another property
  • Your savings, including ISAs
  • An inheritance (this is really only acceptable if the inheritance has been paid or is under probate)
  • Investments, such as bonds
  • Pension lump sum

How much can I borrow on residential interest only?

Like any other mortgage, your income will be taken into account.

Some lenders may consider a part repayment, part interest-only mortgage.

For example, if you’re looking to borrow £200,000 but your income and repayment vehicle might not stretch that far, the lender might offer you £100k of interest only and the other £100k on a repayment basis.

What LTV can I get for residential interest only?

In terms of what you can borrow, most lenders will cap your loan to value at 75%. Some will offer 80%, and a handful will offer up to 85%.

The source of your deposit (such as gifted deposits or overseas cash) can also affect which lenders will work with you.

In mortgage terms, a ‘gifted deposit’ specifically needs to be given as a gift (and not a loan with expectation of repayment). The gift can be used in conjunction with the applicant’s own savings. Most lenders are happy with gifts from family, some will accept gifts from friends.

Lenders will often ask for a written declaration from the gift-giver that they’ll have no financial interest in the property. If the giver dies within 7 years, the gift may be subject to inheritance tax.

What is the maximum I can borrow on my income?

Most providers will lend 4 times your annual income, some will offer 5, and a small number will offer 6.

Like any other mortgage, they’ll also factor in a range of income sources.

These include:

  • Conventional employment
  • Benefits
  • Pension income
  • Other sources - such as a second job or side business.

They’ll also consider self-employed people, and will look at factors such as:

  • How long you’ve been self-employed –
    Most will consider 3 years of employment, some take 2, less still will consider 1 year or 9 months.
  • Income drawn from your business –
    (usually net profit - taken as a personal salary and/or as dividends). Most will look at 3 years of this income, some 2 - and a smaller number will consider last year’s takings.

How does bad credit affect interest only residential mortgage?

Your credit history (particularly bad credit) can affect your eligibility and reduce the number of lenders available to you.

Bad credit is one of the main factors impacting your eligibility for a mortgage, but whether or not you’re accepted will depend on the severity and/or recency of the events.

Things that affect your creditworthiness can include:

  • A low credit score
  • Previous mortgage arrears
  • Defaults
  • County Court Judgements (CCJs)
  • Individual Voluntary Arrangements (IVAs)
  • Debt Management Plans (DMPs)
  • Bankruptcy
  • Repossessions

Don’t panic: As we said before, you may still have options. The advisors we work with can guide you, even if you have a bad credit history.

Residential interest only mortgages on different property types

The type and age of a property can also affect your eligibility.

Providers are often reluctant to lend on listed buildings, high-rises or properties of usual construction (such as thatched roof buildings, or concrete prefabs). Other lenders may specify a minimum or maximum age for the mortgage.

Thankfully, there are lenders that specialise in these types of property, so to get the right advice make an enquiry and we will refer you to one of the experts.

Is interest only equity release an option for older borrowers?

Interest only equity release products exist for older borrowers. As a general rule, the minimum age is 55. Full repayment is usually due upon death or moving into residential care.

The loan-to-valuation is normally based on the market value of the property and age of the youngest applicant - and proof of income is usually required.

Interest only in buy-to-let

Interest only is actually the more popular option in buy-to-let, but the rules are a little different to interest only residential mortgages.

Traditionally, banks treat buy-to-let mortgages as higher risk and, as such they are often more expensive.

Usually, you’ll need a higher deposit (at least 25% of the property’s value, although some lenders will consider just 15%) and the overall fees tend to be higher.

Many also factor your personal income in, with some banks unwilling to lend to anyone who earns below £25k annually (although some have no minimum income requirements).

Lenders will often insist upon rental returns that are at least 125% of repayments, as a buffer against void periods, often much higher than this for higher rate tax payers and those buying properties that are considered more risky.

On top of this, lenders will request a repayment strategy - this will vary by lender, much the same as with a residential mortgage, but in general simply selling the property is considered acceptable.

As with everything, we’d advise you definitely speak to one of the experts we work with.

Why you often can’t use a residential mortgage in buy-to-let

As with other mortgage types, lenders do not allow residential mortgages to be used in buy-to-let without written consent to let. And some won’t even grant permission.

Many people find themselves ‘accidental landlord’, through inheritance or moving in with a partner – often simply informing the lender is acceptable, but some lenders will require a remortgage to buy to let.

Using a residential mortgage for buy-to-let can, in some instances, constitute mortgage fraud. The penalties for using a residential mortgage in buy-to-let without permission can be steep. Your provider might increase the mortgage rate - bringing it into line with their BTL products. They can also level financial penalties, or revoke your mortgage entirely.

Residential interest only mortgages in second homes

It’s also possible to get a residential interest only mortgage for a second home. Usually, the provisos state that you need to live in this home for a minimum amount of time, and not rent out the property or use it for business purposes.

Can I get a shared ownership mortgage on interest only?

Lenders are usually only willing to consider an interest only mortgage if you have 50% deposit or more, and that you can show an acceptable exit strategy.

The reality is that most housing associations are usually unlikely to agree to an interest only mortgage on a shared ownership purchase.

Can I get a self-build on an interest only mortgage?

There are some lenders who will accept an application for an interest only on a self-build. The main advantage is that it can help with cash flow at the outset of the construction phase.  The downside is that you will need a larger deposit as most lenders will only lend up to 75%.

To get the right advice on which are your best options, talk to one of the advisors we work with who are experts in self-build and interest only mortgages.

Interest only secured loans on residential property

Interest only secured loans work in a very similar fashion to interest only mortgages. Both use the house as collateral, and both require you to pay the full balance. The main difference is that secured loans are second (or third) mortgages, added on top of an existing mortgage.

Some secured loan lenders can also be more flexible than first charge mortgage lenders, often offering more generous maximum loan amounts and considering more severe and recent credit issues.

Large interest-only mortgages

With property prices going up substantially over the last few years, there are some lenders who are willing to consider interest-only mortgages in the seven figures. If you have sufficient income or assets, it’s quite possible to get an interest-only mortgage on a UK property worth a million pounds or more.

You should use a specialist ‘whole of market’ mortgage broker for this. The brokers we work with are experts in this area and, depending on your circumstances, they'll be able to give you the right advice and match you with the best lender.

Where can I get the best residential interest only mortgages?

Every lender is different, which is why we work with ‘whole of market’ mortgage advisors who have access to the interest only mortgages in the UK, accessing deals across all lenders.

The important thing to remember is that the best deal in the market is only really available to a select few individuals who meet all of the lending criteria.

For those who don’t, getting the best rate can be difficult given the sheer number of lenders and products in the market.

In order to find the best deal, it is always recommended that you make an enquiry and speak to one of the experts we work with to get the right advice to suit your circumstances.

Speak to an expert in residential interest only mortgages

If you’re interested in finding out more, or are looking for an interest only mortgage, we work with a range of experts who can advise you.

Call Online Mortgage Advisor today on 0800 304 7880 or make an enquiry here.

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: 3rd December 2018
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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