Interest Only Mortgages
This is a seriously contentious issue, about which I'm going to discuss the pros and cons:
An interest only mortgage means that the loan has been set up on the basis that you are only obliged to make interest payments on the loan, without repaying any capital. This means that at the end of the mortgage term, the mortgage debt will be the same as it was at the start of the mortgage.
So a £100,000 interest only mortgage, at a 5% mortgage rate, would cost you £5,000 a year or £416.67 per month.
For comparison, a similar repayment mortgage would cost more like £585 per month.
It's easy to see the temptation for people on stretched incomes to take the interest only option
The generally accepted counterpart to an interest only mortgage is an investment of some type, this could, and has been:
So why is this a contentious issue?
Some people are taking out interest only mortgages, with no corresponding investment vehicle to repay the debt at the end of the term. Others are taking out interest only mortgages, then complaining when their debt does not reduce.
I was under the impression from Mortgage Lenders that The Financial Services Authority (FSA) was against Interest Only Mortgages. This does not appear to be the case, as the following, taken from the FSA website demonstrates:
Convert to a repayment mortgage later
"This might be a suitable option if, say, your earnings are low now but are expected to be much higher in future, for example, when you've finished training or gained professional qualifications. Using an interest-only mortgage keeps your monthly payments down until you can afford the higher monthly payments of a repayment mortgage. Because you're putting off repaying the capital you will end up paying more interest and more in total for your mortgage over the term."
This would suggest that the FSA have no problem with people taking out an interest only mortgage on the grounds of affordability, and an assumption that their earnings will increase significantly.
What's not an acceptable repayment vehicle for an Interest Only Mortgage?
According to one lender, the intention to make regular monthly overpayments to your mortgage account, is not an acceptable reason for taking out an Interest Only Mortgage. A stand alone investment ISA is.
They told me that this comes from the FSA. The only conclusion that I can draw is that this lender would have a possible compliance problem with regular overpayments.
How does that work?. Possibly, like this - Nineteen years into a 25 year mortgage, the customer who's been making regular overpayments complains that his mortgage will not be paid off at the end of the 25 year term. As the lender knew what the term was, and knew what overpayments he was making, they should have informed him that he needed to increase his overpayments. Now he's making an official complaint, and demanding compensation.
Whereas, if the borrower has a completely seperate Equity ISA for example, which requires no lender involvement, approval, or checking at any point - then the possibility for a complaint against the lender is reduced to ZERO, should the investment underperform.
Sounds ridiculous really, and definately a case of the compliance tail, wagging the common sense dog.
An alternative view of Interest Only Mortgages
What if you took out an interest only mortgage, and NEVER repaid any capital?
House Price Information taken from the Halifax website gives us the following example - based on average UK property prices.
Purchase Price in 1983 is £29,993.
Value in 2006 is £170,238.
If you had bought that average property in 1983, and made no capital repayments, how would you feel now?
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