Mortgages.scot

The best place to start with this is back in the 80s and 90s. That is when Interest-only mortgages were most popular. They were popular simply because they were cheaper than the more standard capital and repayment mortgages.

Take a £100,000 mortgage over 25 years at a rate of 5%, for example. If a borrower took this out on an interest-only basis, it would cost £417 each month compared to £585 on a capital and repayment basis, saving £168 each month. Remember that mortgage rates were much higher in the 80s and 90s. In Oct 89, they peaked at 14.88%. So, any opportunity to bring those payments down was well received, and interest-only payments became a popular option.

Where did it go wrong in the 80s and 90s?

Simply put, there was poor advice on the part of the lenders and not enough action by borrowers.

For the most part, lenders were promoting interest-only mortgages as a very safe option for borrowers based on the growth of property prices. Taking out a mortgage of £100,000 on a property valued at around £110,000 over 25 years was being marketed on the basis that by the time that 25 year term was at an end, the property would be valued signficantly higher.

Many were told the property value would be high enough that they would be able to sell it, repay the £100,000 owed to the lender and have enough left over to buy something smaller and have no mortgage on that new property.

That is indeed what happened to many. Unfortunately though for many others it didnt. Some would be able to repay their mortgage but not afford anything else. For others there wasnt even enough to repay the mortgage.

There is no doubt many borrowers were misled at the time. But, for many, this came to light early enough during the mortgage term that something could have been done. Switching to a more standard capital and interest mortgage or making overpayments to reduce the £100,000 balance as much as possible. Many didn't do that and instead focussed on blaming the lender and taking no action, expecting lenders to "fix it".

As at the end of 2022 there were 702,000 interest-only mortgages in the UK. The Financial Conduct Authority has suggested that about 50% of those borrowers may be too optimistic about their ability to repay the mortgage when it comes. Research suggests around 82% of respodents were confident they could repay, with 36% expecting some shortall. Modelling puts that nearer 46%.

Can you still get an interest-only mortgage?

Yes. Most lenders still offer them, although they are generally restricted to those with higher incomes. Barclays for example require a borrower to have a minimum income of £75k or joint incomes of at least £100k. Likely looking for higher income earners who can overpay than wait for the mortgage term and hope there is enough to repay. Also, the expectation is that their income will continue to increase and therefore in a much better financial position to deal with a potential shortfall.

Other lenders offer interest-only to borrowers who earn less than the above but with a catch. They will assess mortgage affordability as a capital and interest mortgage over 25 years. This is to ensure that a borrower could afford the mortgage on that basis and are not simply opting for interest-only as they can't afford it any other way.

In addition, all lenders are now much more driven to check with borrowers to see whether they are on track. Contact will be made with clients at points throughout the mortgage term and where appropriate alternative options are discussed if there is any concern.

So, they are still available but not as readily available as they once were.

Should you get an interest-only mortgage?

You will not be surprised when I say it depends!

I come across many borrowers whose circumstances differ. Here is a couple of examples.

• A borrower has another property that is being rented that not only provides an income but has a mortgage that will be repaid sooner than the one being applied for and will provide enough on sale to repay the mortgage. They don't want to sell that existing property now as it's expected to be worth more. So, taking an interest-only mortgage for their new home saves some money whilst having a clear strategy to repay in the future.
• A borrower receives good bonuses yearly and will reduce the capital balance by different amounts yearly. They want the flexibility to choose how much of the capital to repay.
• Similar to the above point, some who have good bonuses, commissions, or other additional income will invest that money to grow it and allow them to repay the capital and then repay the mortgage capital at a point in the future.

Lenders who offer interest-only will disclose what they consider to be acceptable ways to repay the capital.