In these times of financial insecurity, it’s only natural to wonder ‘what if I can’t pay off my interest-only mortgage at the end of the term?’
Read through this article to find out what happens at the end of an interest-only mortgage and what are your options if you can’t repay the outstanding loan.
There are two main types of mortgage, an interest-only mortgage and a capital repayment mortgage.
An interest-only mortgage in the UK is a type of loan where you only pay the interest each month instead of repaying the amount borrowed.
This means that your monthly payments will be lower than with a traditional mortgage, but you’ll still owe the full amount of the loan at the end of the term.
To find out how an interest-only mortgage works in the UK, it’s best to look at a practical example.
Let’s say you take out a mortgage for £120,000 at a 5% interest rate over 25 years. Over the 25-year term, your monthly payments would be £500 in interest alone. The amount of the loan won’t change, which means that at the end of the 25-year term you will still owe £120,000. The monthly payment for a repayment mortgage, on the other hand, is much higher and comes out to £702.
Note: These figures are for illustration purposes only and do not guarantee accuracy in actual amounts or figures. The actual amount due depends on your interest rate, the value of the deposit and several other factors.
To find out which lenders give the best mortgage rate, take a look at this guide.
When your interest-only mortgage term ends, you will have to repay the loan in full.
So, you need to have a repayment plan in place even before your interest-only mortgage is ending. Otherwise, it will be very hard to pay off the full amount at the end of the term.
Some examples of an acceptable interest-only mortgage repayment vehicle include:
If paying off the interest-only mortgage at the end of the term poses a challenge, your lender may repossess the property. If the value of the property is still not enough to cover the mortgage, then you would have to use other assets to repay the loan.
In case you can’t afford to pay off all the capital, there are some options to look into.
It’s possible to arrange an extension of your mortgage with your lender by postponing the repayment date. However, this still leaves you with repaying the full amount after the extension is over.
Getting an interest-only mortgage extension is a good option if you are expecting some money in the near future, such as a bonus or an inheritance.
Note: If you decide to extend the mortgage term, you must carefully balance out your short-term spending with long-term plans so you would have enough to pay off the capital once the extension is over.
You can take out a remortgage with a new lender on your existing property and use that money to pay off your outstanding loan. Bear in mind, though, that remortgaging with a new lender means you are applying for a loan from scratch. In other words, lenders might not approve a new mortgage on the property if you don’t meet certain requirements.
These include, but are not limited to:
It is a good idea to talk to a mortgage broker before going down this road. An expert will not only advise you if remortgaging is the right choice for you but will also help you find the best deal for your needs.
If you are at least 55 years old and have an interest-only mortgage, an equity release may be something worth considering.
If your property is worth more than what you paid for it, i.e. you have positive equity, you could release this equity and pay off your interest-only mortgage.
Releasing equity is not a simple procedure, so it’s best to consult a specialist adviser who will present all the options available to you, helping you make the best decision for your financial situation.
Building enough savings or profit from your investments can be best used to pay off your interest-only mortgage. So, if you have a cash or stocks and shares ISAs, you can use the savings to pay off your loan. However, bear in mind that the value of certain investments has gone down recently, so you might not have enough saved up to repay your interest-only mortgage.
This is the most common exit strategy for borrowers who have problems paying off an interest-only mortgage at the end of the term. The only issue with this scenario is that house prices could go down, so you might be forced to sell the property and still not have enough money to repay the loan.
The lender might agree to switch your mortgage type to a repayment loan. In this case, your monthly payments will increase significantly.
There is also the option to switch to a part and part mortgage, i.e. a mortgage that is part interest-only and part capital repayment. This will also increase your monthly mortgage payments and leave you with the capital to repay at the end (although by that time it would be considerably lower).
A final option would be to borrow money from friends and family. Although this would involve paying less (or no) interest, you would still have to find some way to repay the money eventually.
What are the drawbacks and advantages of an interest-only mortgage and is it always the best choice for you?
Some of the interest-only mortgage advantages can include:
You pay less a month than you would with a capital repayment mortgage. This gives you leeway for daily living expenses, home improvements, or investments. The monthly payments are affordable for most first-time buyers or those in middle to low-income households.
Most landlords opt for an interest-only mortgage as a way to keep their overheads low. They usually end up selling the property at the end of the term to repay the capital.
To find out more about a buy-to-let mortgage, read through this insightful article.
Are there any disadvantages of an interest-only mortgage?
One of the biggest interest-only mortgage disadvantages is that you would have to pay off the entire loan at the end of the term. Coming up with such a large amount of money can be a problem for most borrowers, even for those who have saved carefully over the years or have an acceptable repayment vehicle in place.
Another downside is that interest-only mortgages come with higher interest rates. There might also be redemption fees to pay.
It can be very difficult for first-time buyers to get an interest-only mortgage as they would have to prove they have good income or savings they can use to repay the loan, which cancels out the benefit of lower monthly payments.
Although mortgage statistics indicate that people today are less likely to default on a mortgage repayment—the number of repossessed residential mortgaged properties decreased by 88% in 2020, you should not relax and forget all about your loan.
Keep track of your repayment plan to make sure everything is running smoothly. If you don’t have one, contact your lender as soon as possible or consult a mortgage broker to explore the options available to you.
Yes, selling your property after your interest-only mortgage term is an option. You should be aware that the value of your property could go down in time, so you might not be able to sell it at a profit.
If you are thinking of paying off an interest-only mortgage early and you are on a fixed interest rate, your lender might charge early repayments fees. Check the mortgage terms or talk to a financial adviser to see if an early interest-only mortgage repayment is a good option for you.
If you have over 50% of equity in your property and a solid repayment vehicle, you probably have nothing to worry about.
If this is not the case and you are wondering ‘what if I can’t pay off my interest-only mortgage’, talk to a mortgage adviser, revise your repayment plan or consider switching to a repayment mortgage, if possible.