Interest-Only Mortgages

The monthly repayments you make on an interest-only mortgage only go towards paying off the interest charges, rather than a combination of these and a proportion of the amount you borrowed. The actual loan amount is paid off at the end of the mortgage term as a lump sum. This means is it essential that you have an investment or savings plan in place to pay off the outstanding amount at the end of the mortgage term.

Generally, your mortgage lender will offer to arrange a savings or investment plan for you. If you accept their plan, you will usually take out a combined interest-only mortgage and investment deal. The three main types are Pension Mortgages, ISA Mortgages and the previously popular, Endowment Mortgage. Each one has its own advantages and disadvantages to carefully consider before making a decision.

If you decide not to take out an investment or savings plan with your mortgage provider, you must arrange another way to repay the loan. You have several options to do so.

The first is to save or invest, choosing your own plan. This could include your own stock-market based investments, or making regular deposits into a savings account. Remember that although a savings account is 'risk-free', you must be disciplined enough to save regularly: if not, your savings are unlikely to grow sufficiently to cover your mortgage. If you invest in the stock market, remember that you risk the value of your investment going down.

Alternatively, you may find converting to a repayment mortgage later on in the term is best for you. By switching to a repayment plan, you begin to pay off the actual amount you owe as part of your monthly repayments. So long as you make all the repayments on-time and in-full, you will have paid off your mortgage at the end of the term.

In other cases, you may be able to use a lump sum from other income, such as a large inheritance, or the sale of your business. Naturally, it depends on your circumstances whether or not this type of income is guaranteed and whether you would be able to use it to pay off your whole mortgage.

Lastly, if you do not need to continue living in the property, you may decide to sell it at the end of the mortgage term. In most cases, this will raise the required funds to repay your mortgage, and may even leave you with a small profit. Remember however that you would no longer own the property, despite having paid hundreds of monthly payments to your mortgage provider.

You will need to check the performance of any savings or investments regularly to ensure that they will be sufficient to pay off the loan amount. If they do not grow sufficiently you could be faced with a 'shortfall', which is the difference between the amount you owe and the amount you have saved to cover it. If you face a shortfall, you must find another source of income to cover it because you are still liable for the full loan amount. See Making up a Shortfall for more details.

Interest-only mortgages tend to be cheaper than repayment mortgages because you are only paying the interest charge and making a slight contribution to your investment or savings plan, as opposed to paying off a proportion of your mortgage too. For this reason, an interest-only mortgage may be especially suitable for first-time buyers or those with a modest income, since repayments are often more manageable.

For more details on interest-only mortgages, see:

• Endowment Mortgages
• Pension Mortgages
• ISA Mortgages