If you are among the one in five people who currently have an interest-only mortgage or only part re-pay each month, you need to take steps now or face a potential shortfall.
That’s the message from City regulator, the Financial Conduct Authority (FCA), which has warned of a “ticking time bomb” among unprepared borrowers.
There are currently 1.67 million fully interest-only or part-capital repayment mortgage accounts in the UK, amounting to 17.6% of all home loans. And Jonathan Davies, the FCA’s executive director of supervision, says he is “very concerned that a significant number of interest-only customers may not be able to repay the capital at the end of the mortgage and be at risk of losing their homes”.
Back in 2012 the regulator warned that the interest-only mortgage market was a “ticking time bomb” after it helped to fuel a housing boom before the 2007-09 financial crisis.
For most homeowners your mortgage will be the biggest single debt you will ever have, so it’s little surprise that the lower monthly cost of an interest-only deal can be very appealing. However, when you have an interest-only mortgage you have to be on the ball when it comes to paying it off, otherwise you could be left with a huge sum to clear at the end.
Rising interest rates
In a rising interest rate environment, reducing your debts is key. Now, while the Bank of England has only made one increase in the base rate in a decade, all the signs are the interest rates on home loans will go up further in the future, not come down. When that happens, as borrowing becomes more expensive, mortgages inevitably take longer to clear.
Unlike with an interest-only mortgage, a repayment mortgage means you’re gradually whittling away the initial sum you borrowed, plus any fees that have been added as well as the interest incurred. All of which means that, while your repayments will be more expensive, at least you know you are on track to repay the loan in full by the end of the mortgage term.
With an interest-only mortgage it’s a very different story. That £200,000 or so loan you took out 25 years ago (plus any extra borrowing you may have added along the way) will still be sitting there – and you need some way to pay it off.
Time may be on your side
The good news for so many interest-only borrowers is that the date they’re due to pay-off their loan is many years , if not decades, away. According to the Council of Mortgage Lenders, 29% of interest-only mortgages are not set to mature until at least 2028.
If you’re one of these people, then the even better news is that with a time-frame like that you have plenty of time to ensure your investments are working as hard as they can, so that you are in a position to clear the loan when the time comes. As long as you start now.
Paying off an interest-only loan is something that has to be planned. And it’s important to remember that it’s your responsibility, not your lender’s, to make sure you have plans in place to eventually repay the loan in full.
So what are your options?
1. Build up your investments
We each have an annual ISA allowance which enables us to invest up to £20,000 tax-efficiently in the current tax year, so a couple has double the allowance to work with.
When you’re saving for a large sum, the ability to shelter that sort of sum and keep more of your hard-earned cash out of the tax man’s hands, can make a big difference to the amount you can save; especially if you’re a higher rate taxpayer.
By investing lump sums, as and when you can, and drip feeding regular savings into the stock market as a matter of course, with time on your side you should be able to grow a substantial pot of money that an towards to clearing your mortgage balance.
Make sure you regularly review your investments to make sure you are still on track to build up the sort of sum you need.
2. Sell the property and repay the loan
Many interest-only homeowners say they’ll sell up to clear the balance, but that’s not always ideal or even possible. You may struggle to find a buyer, the value of your property could be less than the sum you owe on the mortgage and besides that, you might not want to move. Even if you do, you might find it difficult to get another mortgage, especially if you’ve already retired.
3. Rely on a windfall or bonus to clear the loan
During the property boom and pre-credit crunch many mortgage lenders were happy to hand out interest-only loans to young professionals on lower salaries, but with good prospects for future earnings. The short-term advantages were evident to low earners, while the 25 year time frame gave them ample time to build up their income and invest some of their bonuses along the way. If you’re relying on this as a way to clear at least part of your mortgage, then make sure you regularly review your finances to ensure you’re on track.
4. Switch to a repayment mortgage
One way to guarantee you’ll clear the balance by the end of the mortgage term is to switch to a repayment deal. Your current lender should be more than happy to do this for you, as lenders have been under pressure to work with their customers to ensure interest-only loans are repaid in full and on time.
It will mean your monthly repayments will go up substantially, but you may be able to extend the mortgage term to make repayments more manageable.
5. Switch part of your mortgage to repayment
If switching your entire mortgage to a repayment basis is too costly, or you would prefer not to tie-up all your money, you could ask if you could switch part of the loan. That way you know you’re taking care of some of the balance and you’re leaving the rest of your cash free to invest.
Make the right choices and invest wisely and you could be in a position to clear your mortgage at the end of the term and still have an investment pot that you can continue to grow for your retirement years, or whatever else comes up before then.
The value of investments and the income from them can go down as well as up, so you may not get back what you invest. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment or action. You should regularly review your investment objectives and choices and if you are unsure whether an investment is suitable for you, you should contact an authorised financial adviser.