Interest Only Mortgages

Interest only mortgages are extremely popular in the current house buying market. Because the monthly payment on an interest only mortgage is lower than the payment on a repayment mortgage, many homebuyers mistakenly assume that this is the most affordable type of mortgage. In order to understand why this is not the case, you must first understand how mortgages work.

Interest Only Versus Repayment

When you take out a mortgage on a property, you are agreeing to pay back the amount you borrowed, plus interest. The interest is like the “fee” you are charged for the privilege of borrowing money. In a traditional repayment mortgage, your monthly payment has a portion applied towards the capital debt and a portion applied towards the interest.

With an interest only mortgage, on the other hand, the monthly payment is only applied towards the interest portion of the mortgage. This is what makes the payment appear to be lower than a traditional mortgage payment. However, you are not exempt from the requirement to pay the capital debt. When the loan comes to term, you will still be responsible for the capital debt. If at this time you cannot repay what you owe, you will lose your property to your lender.

How to Use Interest Only Mortgages Correctly

So is an interest only mortgage a terrible idea? Not necessarily, but it does require some forward thinking. This type of mortgage only works if you can create a plan to allow you to repay your capital debt while you are making your monthly interest payment.

So how can you repay your capital debt on an interest only mortgage? You have several options to pay down what you have borrowed. The best way to pay down your debt is to use an ISA, or individual savings account. This type of savings account allows you to invest money tax free, and then you can use that money to pay down the loan. You may be able to cash out your pension plan to pay your mortgage, but this is typically considered a bad idea. Endowments have been used in the past for interest only mortgages, but they rarely work well.

When you are choosing the mortgage structure that is best for you, be sure to get advice from your financial advisor. Remember, you may find that your repayment plan does not work as you anticipated, and this could leave you with a huge debt that you cannot repay. Take the time to do your research, create a repayment plan, and only choose an interest only mortgage if you have a way you can repay the loan.