Interest-only mortgages – what are your options?
Interest-only mortgages have been in the news lately, and I’ve been contacted by several people asking what they should do now that their mortgage is due up and they still owe in excess of £100,000.
The FCA released a notice about their concerns on this subject at the beginning of this year because 2018 shows a peak in the number of mortgages coming due, especially interest-only mortgages. There are further peaks due in 2027 and 2032.
We’re talking big numbers here: 1.67m interest-only or part-interest mortgages are in the marketplace at the moment, which represents nearly 20% of all outstanding mortgages in this country. If this doesn’t affect you, it’s likely to affect some of your friends and family. So how should you handle the situation in advance of the end of your term?
Interest-only mortgages were popular before 2007 and the financial crash. People were looking for more affordable repayments and thought house prices were always going to keep going up.
Most of those people with an interest-only mortgage should have set up an investment or repayment vehicle to run alongside it – possibly a PEP or an ISA, or even an endowment policy or personal pension plan – giving them a lump sum to pay off the borrowing at the end of the term.
An interest-only mortgage is one where you pay only the interest and not the mortgage balance itself. Let’s say you have a £100,000 mortgage charged at 5% annual interest, at the end of the year you’ll have paid £5,000 but you still owe the £100,000; fast forward 25 years and you still owe that £100,000.
The biggest concern is that when you get to the end of your term, the 25 years in this example, how are you going to pay it back? You’ve got to make sure you have a strategy in place – so what are your options?
Evaluate (and re-evaluate) your original thinking
Step 2 of The Money Plan is to get financially organised by knowing what you’ve got: your assets and liabilities, your income and expenditure. When it comes to an interest-only mortgage, what assets do you have that you can offset against your final capital payment?
Did you take out an endowment policy, ISA, PEP, or even a pension with a plan to pay off the mortgage borrowing? If you did, you have a few options available.
Option 1: Cash in and switch to repayment terms
Whatever your strategy for repayment was when you took the mortgage, you should re-evaluate it now. Why? Because as a rule of thumb, if you have an endowment policy or ISA that was put in place to repay the mortgage at the end of your term, then for most people it’s best to cash in and pay down that money to repay some of the borrowing now. At the same time, you should switch over to a repayment mortgage that will see your loan completely cleared at the end of its remaining term.
An important note to remember: if you’ve had a policy running for less than 10 years then check for any tax liability or surrender charges before you cash it in; if in doubt, seek professional advice first.
Doing this is probably going to be your cheapest long-term option. You’ll have a smaller remaining balance, though you’ll also have higher monthly payments. If you find the new premiums too high, ask if you can extend the term and push it out a little longer – this way you’re still repaying the mortgage itself but it will bring your monthly repayments down. Bear in mind not to extend it too far into the future – I don’t want you to extend debt past your retirement date because when we arrive at retirement, we want all debts repaid and a nice pension to live off.
What if I can’t afford the new premiums?
If the new monthly repayments are still too expensive then it may be necessary to leave some of the mortgage on interest-only – but remember that money will still be owed at the end of your term, don’t bury your head in the sand about that (see downsizing below). Try to chip away at it along the way if you get bonuses, commissions or sell something and have extra cash.
Option 2: Maintain your position
If your repayment vehicle is on track and you’re happy with it, then you may choose to maintain your current status quo on the understanding that your strategy will cover your final lump sum payment. But please, do keep an eye on it and keep it under regular review, this is a higher risk approach. You need to be comfortable taking that element of risk.
Option 3: Switch and maintain!
If you can afford to switch the interest-only mortgage to a repayment one over the remaining term, plus keep your savings vehicle going, then that will give you a nice addition to any retirement funding or plans you have. But for many, switching AND continuing the investment vehicle will be expensive and unaffordable.
Option 4: Cash in and downsize
What you might have to do at the end of the term (or even before it so that you’re not under pressure) is to sell your property. Downsizing might have always been part of your strategy, or it might be something forced upon you by your finances.
Either way, if you cash in your investment vehicle now and pay off some of your mortgage, then when it’s time to downsize you’ll have lots of equity, potentially enough to buy a smaller property and have some money left over.
To emphasise, interest-only mortgages are affecting a lot of people, including some you know, so please share this post with anyone you feel could benefit.
The Financial Conduct Authority has published a guide about what to do if you have an interest-only mortgage, which you can read here.