Can My Mortgage Be Interest-only?

Nikka Sulton

Can My Mortgage Be Interest-only?

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Typically, a mortgage involves borrowing a sum and gradually repaying it, along with interest, over a span of 25 years. But what if, instead, you solely cover the interest, neglecting the principal amount? While this might seem unconventional, it finds its niche, particularly in buy-to-let investments. Explore the reasons behind the prevalence of interest-only buy-to-let mortgages and their potential advantages for landlords in our comprehensive guide.

What Is an Interest-Only Mortgage?

An interest-only mortgage is a mortgage variant where the borrower is obligated to cover solely the interest on the loan for a predetermined period. The principal amount is typically settled either in a lump sum on a specified date or through subsequent payments.

Understanding an Interest-Only Mortgage

Interest-only mortgages can be configured in various manners. They may entail making interest-only payments for a predetermined period, providing it as an optional arrangement, or maintaining it throughout the entire loan term. In some cases, certain lenders may offer interest-only payment options exclusively to specific borrowers.

Typically, most interest-only mortgages necessitate only interest payments for a specified timeframe, commonly lasting for five, seven, or ten years. Subsequently, the loan transitions into a standard payment schedule, referred to as a fully-amortized basis in financial terminology. During this phase, borrowers are obliged to make payments encompassing both interest and a portion of the principal.

Interest-only loans are frequently structured as a specific category of adjustable-rate mortgages (ARMs), known as interest-only ARMs. Within this arrangement, borrowers pay solely the interest, often at a fixed rate, for a set number of years, denoted as the introductory period. Following the conclusion of the introductory period, borrowers commence repaying both the principal and interest, and the interest rate becomes subject to adjustments.

For instance, opting for a “7/1 ARM” implies that the initial interest-only payment period extends for seven years, after which the interest rate undergoes annual adjustments.

How do I payoff an interest-only mortgage?

Upon reaching the culmination of the interest-only mortgage term, borrowers face several alternatives. For instance, some borrowers might opt for refinancing their loan once the interest-only period concludes. This can open doors to new terms, potentially reducing interest payments alongside the principal balance. Alternatively, certain borrowers may decide to sell the property they mortgaged to settle the loan. In contrast, others may elect to make a single lump-sum payment when the loan matures, having amassed the required funds by forgoing principal payments throughout the preceding years.

What are the pros and cons of interest-only mortgages?

Benefits of interest-only mortgages:

For some, the appeal lies in the flexibility of commencing with lower initial payments and gradually increasing them as income or savings grow towards the mortgage term’s conclusion.

Monthly payments are notably reduced compared to a repayment mortgage, limited to covering loan interest.
Should your investments perform well, the possibility arises for swifter loan repayment without necessitating property sale or refinancing. If you anticipate having ample funds to cover a property’s full cost without delay, a repayment mortgage might not align with your circumstances.
However, if this capital won’t materialize for several years, an interest-only mortgage presents an avenue to purchase property now while facilitating the full payment upon mortgage term completion.

Disadvantages of interest-only mortgages:

The primary drawback lies in the weight of responsibility associated with ensuring full repayment at the conclusion of the interest-only mortgage term.

Typically, you’ll incur higher total interest costs compared to a repayment mortgage since the interest-bearing amount remains constant throughout the term.
Your monthly payments exclusively cover interest, leaving the full principal outstanding at the term’s end.
Maintenance of your repayment vehicle is an added obligation alongside the mortgage.
If your repayment vehicle hinges on investments, pension provisions, an inheritance, or property value escalation, there’s a risk it won’t generate sufficient funds to settle your mortgage.
Similar to repayment mortgages, early repayment of an interest-only mortgage on a fixed rate might incur early repayment charges. Review your mortgage terms for specific details on this matter.

Are buy-to-let mortgages that are interest-only a good idea?

Determining whether an interest-only mortgage suits you isn’t straightforward (as circumstances vary). Nonetheless, it’s a common choice among landlords to pay only the interest. Opting for a repayment mortgage on your buy-to-let might yield slim or even non-existent profit margins, but it accelerates your property’s payoff.

Why would anyone want an interest only mortgage?

Interest-only mortgages might not suit everyone, but they can be considered if you have a well-defined strategy to accumulate sufficient funds for the eventual repayment. This could involve a relatively secure investment approach, an assured future income source, or an expected windfall. However, it’s crucial to have a full awareness of the associated risks.