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Should you opt for an Interest only mortgage?

When you are buying a home abroad it is tempting to opt for an interest only mortgage. You won’t be offered one by a Spanish bank, and other countries that are popular with foreign buyers tend to only offer repayment mortgages based on what you can actually afford rather than your income and other assets. In other words, they will want to know all your outgoings against income before making a decision.

However, if you are buying a second home for holidays in your own country for example, what is the issue with having an interest only mortgage? Well, it is because you are only ever paying off the interest on the loan and not making a dent in the underlying capital. The financial regulators are aware that this is a crisis waiting to happen, which is why they have restricted the types of borrower able to access such a mortgage. As the FT reported, a “repayment crunch” is looming for owners who won’t be able to cope if house prices fall and interest rates rise.

One mortgage broker in the UK painted a rather grim scenario: “We’ve definitely got an interest only mortgage ticking time bomb scenario. Lots of people in the past took out interest only mortgages at much higher loan-to-value ratios than would now be granted, and people took them out without thinking about how they would pay them off.”

The craze for interest only mortgages started in the 1990s when they were sold with endowment policies. The policy was designed to repay the loan capital at the end of the loan period, while the borrower just paid the interest. The problem arose when the endowment policies, which are linked to the stock market, failed to produce the sums needed to pay off the capital. Borrowers complained that they had been mis-sold the product and didn’t understand the risks.

We are about to see the outcome of this 90s boom for interest only mortgage as 2017 and 2018 are years when a great many will reach peak maturity. An additional factor is that many of the people who took out these mortgages will be approaching retirement, which means they may not be considered for another loan if their endowment policy doesn’t cover repayment of the capital.

Interest only mortgage – why they might be appealing to some

The interest only mortgage had obvious appeal, especially for those who couldn’t afford the more conventional repayment mortgage that combines capital and interest. Buyers were drawn to them because they were cheaper and easier, but in the end any of them have been given a headache. The only solution is to see if a lender will switch them to a repayment mortgage, but this depends on age and income and more stringent affordability tests. If owners can’t demonstrate their ability to pay a repayment mortgage then their only option is to sell the property and repay the loan that way. However, that raises a whole new set of problems, particularly property price rises. In the end, an interest only mortgage seemed like a good idea, but turned out to be a bad one. So, don’t be tempted.

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