If you’ve got a mortgage and you always make your monthly repayments, then you probably think that when your home loan matures, you own your house and have nothing else to pay. And yes, for most of us – those who have repayment mortgages - that’s the way it works.
But if you’re one of the estimated million-plus homeowners with an interest-only mortgage then when your mortgage finishes, you are going to have to repay the original amount you borrowed. With a repayment mortgage, your monthly payments are made up of interest and repaying the capital. But with interest-only, you pay (obviously enough) just the interest.
If you took out a mortgage in the 1980s or 1990s you may well have been sold an interest-only mortgage linked to an endowment policy. And you might still have the interest-only deal even if you’ve long got rid of the endowment. Or maybe you just took out an interest-only mortgage without arranging a repayment plan. Whichever, you have to repay the original sum borrowed on maturity. If you haven’t been saving regularly, this could cause problems.
Many who took out interest-only mortgages stayed on this basis because the monthly repayments are cheaper. According to this calculator if you took out a £130,000 25 year mortgage with a rate of 3% then your monthly payments on an interest-only loan would be £325, but on a repayment basis, £616. However, over the full 25 years you’d pay back £227,449 on the interest-only deal (the £130,000 originally borrowed plus £97,449 in interest) but £184,911 on the repayment. It’s lower because you’re reducing the £130,000 originally borrowed with every monthly payment so the interest is less.
Having an interest-only mortgage is fine – as long as you know how you’re going to repay the capital at the end. Lenders have written to borrowers with interest-only loans to remind them of this – but, says the Financial Conduct Authority ‘customer engagement rates are low’ – in other words, people are ignoring the warnings.
So what should you do if you’ve got an interest-only loan? As long as you’ve got equity in your home then remortgaging onto a repayment deal is the best idea – and you’ll be able to pick up a good rate at the same time. Or if your mortgage still has at least five (and ideally 10 or more) years to go, then consider investing every month into a share Isa. If you only have a short time to go until the mortgage matures, then your options are limited: you’ll either have to save a lot of money into an savings account (you’re too close to repayment to risk investing). Or you could always sell up and repay the mortgage from the proceeds, using what’s left over to buy a new property. The one thing NOT to do is to ignore the situation: it won’t just go away. You will eventually have to repay what you borrowed: the sooner you sort this out, the less painful it will be.
See our guide to remortgaging here.
And our guide to investing here.