An Interest Only mortgage is one that only pays off the interest on the loan and doesn’t pay off ANY of the initial loan amount...
Be sure to get your figures right with our mortgage calculator
An Introduction To Interest Only Mortgages
An Interest Only mortgage is a mortgage that only pays off the interest on the mortgage loan and doesn’t pay off ANY of the initial loan amount even after the full mortgage term. Put simply, in contrast, a standard monthly mortgage payment pays off the calculated interest repayment plus a small amount of the initial loan so that the amount is ever decreasing.
An Interest Only mortgage does NOT do that and does not pay off any of the loan so that loan amount is the same after 25 years as it was at the beginning. In short the house doesn’t belong to the borrower unless they have arranged another, separate method of paying off the initial sum. The monthly repayments of an Interest Only mortgage will be less than a standard mortgage for the very reason that they do not include any amount to pay off the loan.
Additional Separate Fund Or Payment Schedule
Lenders will expect an Interest Only mortgage borrower to arrange a separate fund or payment schedule that aims to pay off the original capital amount. Some lenders will ask for evidence of a separate arrangement but many will not. Some will offer the borrower an arrangement of their own. It is up to the borrower to make the arrangement because at the end of the mortgage term if the borrower has not arranged to pay off the loan amount then the borrower will either be forced to sell the house to pay off the loan or it will belong to the lender.
Possible Short Term Solution
The Interest Only mortgage is a valid and legal mortgage that allows low initial payments on relatively large borrowed sums when buying a property but the borrower should be fully aware of the consequences of not having a fund to pay off the loan amount. There are a number of reasons why a borrower might need an Interest Only mortgage for instance if they are guaranteed a sum of money in the future but want to secure a particular house purchase now. Sometimes an Interest Only mortgage is arranged as a short-term solution so that it can be switched to a full standard mortgage when the borrower can afford the higher repayments at a later date.
The Interest Only mortgage can serve a useful purpose in many instances but only when the borrower is absolutely clear about what it will mean in the future and they have prepared for it.