Interest Only Mortgages

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What are Interest Only Mortgages?

Interest only mortgages will mean that your monthly payments will consist of only the interest added to the borrowed amount, with you paying back the remaining mortgage capital at the end of the term. 

Therefore, your monthly payments will be cheaper than that of a repayment mortgage, but will also mean that you still owe the amount you originally borrowed when you reach the end of the mortgage term. 

In order to pay back the capital, you will need to satisfy the lender that you have a suitable repayment strategy put in place before the mortgage starts so that you will have the money to pay off the capital at the end of the mortgage.

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Interest Only Mortgage Types

Fixed Rate Mortgage

A fixed mortgage allows you to pay a fixed rate of interest for a set amount of time. This can be spread over a certain number of years, whether that is 2, 5 or even sometimes extending to10 years. 

Advantages

  • The advantage of using a fixed rate mortgage is that your repayment remains the same each month, helping you to budget efficiently and plan well, knowing that your monthly payments will not change over the course of the fixed term. 

Disadvantages

  • When taking out a fixed rate mortgage, interest rates are not always that competitive and once you have committed yourself to this mortgage type, should you want to get out of your deal early, you may have to pay a large repayment charge. 

Tracker Mortgage

A Tracker mortgage is a type of variable rate mortgage that changes on a monthly basis based on the changes in the Bank of England base rate, staying a set percentage above it at all times. 

This essentially means that your mortgage interest rate can rise and fall each month, causing fluctuations in your monthly payments. 

Advantages

    • The advantage of using a tracker mortgage is that it is generally cheaper than a fixed rate mortgage, particular when the base rate is low. 

Disadvantages

    • For those on a tight budget, a tracker mortgage might not be the right mortgage type for you as monthly payments will fluctuate on a monthly basis. If you are thinking about applying for a tracker mortgage, it is important to understand whether you are able to afford increases in monthly payments.

Variable Rate Mortgage

With a variable rate mortgage, you will pay what is known as the lender’s standard rate of interest (SVR), This will change monthly at the discretion of the lender, tracking the general economic changes within the country and in the lending market. 

Advantages

  • For variable rate mortgages, your monthly payments will reduce if interest rates do. 
  • Also, there is usually no early repayment charge, meaning if you have the ability to pay back the mortgage earlier in full, this will be possible without any penalty. 

Disadvantages

  • Although you are able to be on a relatively low cost variable rate mortgage, usually a fixed rate or tracker mortgage is able to provide more competitive rates.

FAQ

What size deposit do I need for a residential mortgage?

In order to qualify for the best residential mortgage rates, it is best to have a deposit of 30% to 40% of the property’s value. Lenders often offer their best rates to those who are able to put forward a larger residential mortgage deposit as they are perceived to lower risks. This is due to borrowing less and there will be enough equity in the property to cover any short term fluctuations in property values.

What is Loan to Value ratio (LTV)?

Your loan to value ratio is the amount that is borrowed set against the value of the property. If you have a deposit of £40,000, you will need £160,000 to be able to afford a £200,000 property. Borrowing £160,000 for a £200,000 home gives you an 80% loan to value ratio, with your £40,000 deposit accounting for the remaining 20%.

The best rates are with a 60% LTV mortgage which is the lowest available LTV mortgage that you can get. The most common LTV ranges in between the 75/ 80% and often carry competitive rates with manageable monthly payments. 

For first time buyers, a 90/95% LTV mortgage can often be a way to get on the housing ladder. Although they may have more expensive rates, it does offer the ability for first time buyers to gain their own home.

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