By having a mortgage on a repayment basis, the capital and interest will be paid off by the end of the mortgage term as the borrower pays back the interest and some of capital off each month. However with an interest-only mortgage, the borrower only pays off the interest on the mortgage amount that they have borrowed each month.
For the remaining capital amount, the borrower uses savings, investments or other assets that they have (known as ‘repayment vehicles’) to pay off the total amount borrowed at the end of the mortgage term.
It is the responsibility of the borrower (not the lender) to put in place and maintain a credible repayment plan to repay the capital at the end of the term. Examples of repayment vehicles:
- Cash saved in a Savings Account or ISA
- Stocks & Shares ISAs
- Investment Bonds
- Unit Trusts
- Regular Savings Plan (for example Endowment policies)
- Other Properties or Assets
NB: Each lender will specify which repayment vehicles that they will accept as repayment vehicle – not all of the above accepted.
‘Residential’ mortgages refer to mortgages secured on a property that the mortgagee resides in, i.e. not rented out or a commercial property.
It is not wise to rely on a windfall payment in the future, i.e. inheritance or a bonus, to repay the capital, nor is it possible to speculate that property prices will increase enough to enable the borrower to downsize in the future and still pay of the mortgage.
Plus by the very nature of investments, their values can rise and fall, so it is possible that a mortgage borrower has lost their money in the investment before the end of the mortgage term.
A really useful guide from the Money Advice Service: http://comfy.moneyadviceservice.org.uk//system/comfy/cms/files/files/000/000/106/original/MAS_A4_IOM_IOM0001C_ONLINE-June2015.pdf
NB: Many Landlords chose to have their Buy to Let mortgage on an interest only basis as as most landlords will be expecting to sell the property eventually as their repayment strategy. Landlords are often more interested in cash-flow considerations that enable them to gain a regular income stream from the property than owning the property outright by the end of the mortgage term.
If you have any concerns about your existing residential interest-only mortgage or any queries that you may have about interest-only residential mortgages, please feel free to contact us to discuss your concerns further.