Interest Only Mortgage – Repayment Strategy

What are your options with an interest-only mortgage?

Although interest-only mortgages have become less popular, many people still have one and should have a repayment strategy in place. If you have an interest-only mortgage it is important to review your plans as it is suggested that almost half of borrowers will not have sufficient capital to repay their mortgage, known as being in shortfall.

According to the Financial Conduct Authority (FCA) over the next 30 years, 2.6 million interest-only mortgages will be due for repayment. While 90% have a repayment plan, the FCA estimate that 48% will not have enough money to pay off the loan. Half of the shortfalls are expected to be over £50,000, potentially leaving families struggling financially.

Why do you need a repayment plan with an interest-only mortgage?

With an interest-only mortgage you are only paying the interest on the mortgage. This may well reduce your monthly outgoings. But, you are not reducing the amount you borrowed. As a result, when the mortgage term ends, you still need to pay off the initial mortgage. So, you really need a plan for how this money will be repaid.

Even if you have a plan in place, you should regularly review this to make sure it remains on track. If investments have not performed as well as expected, for instance, you could face a shortfall. Knowing there is a potential gap sooner means you have more options to bridge it. If you reach the end of an interest-only mortgage term and cannot pay back the amount you owe, other assets may be at risk.

If you have an interest-only mortgage, there are many ways you can create a repayment plan to fit into your aspirations. 

Savings and investments

You can build up a lump sum that can then pay off the loan. This may include using ISAs or an investment portfolio.

You may also want to consider whether pension investments could be used to pay off your mortgage once you reach retirement age.

Start overpaying your mortgage

If you are in a financial position to make additional mortgage payments, this can help reduce the loan amount. Overpayments will go towards reducing the debt, rather than interest. Therefore, regular overpayments, or a one-off lump sum, can help ensure you are on track to pay off your mortgage.

Before you overpay make sure you check the terms of your mortgage. You can usually pay off 10% of the outstanding amount without incurring any fees. However, this is not always the case.

Taking out another interest-only mortgage or extend the term

If you need more time, using another interest-only mortgage or extending your mortgage term may be an option. This may end up costing you more. It will also mean applying for a new mortgage.

If you are nearing retirement and an interest-only mortgage is coming to an end, one option to explore is a retirement interest-only mortgage. These mortgages do not have a term but will run throughout your life or until you sell your home.

Switch to a repayment mortgage

Switch to a repayment mortgage. With a repayment mortgage you pay off some of the amount borrowed along with the interest each month. If you keep up your mortgage repayments, you will pay off the loan at the end of the mortgage term. However, your monthly payments will rise as a result. You should ensure you can meet this financial commitment.

Downsize

Finally, you can sell your home to pay off any outstanding debt. Of course, you will have to move. For some, this can make sense. But, for others, selling their home will be the last resort.

We have more guides available for first time buyers, home buyers, remortgages and buy to let.

We also recommend The Money Advice Service if you want more detailed information.