Lenders are cracking down on interest only mortgages. Santander, for example, now demands a 50% deposit if you want to take out an interest-only deal. RBS and NatWest insist that borrowers earn at least £50,000 a year if they want an interest-only loan.
With an interest-only mortgage, you pay off only the interest every month. So, at the end of the mortgage term you still owe the capital debt. For example, if you borrow £100,000 you would pay only interest throughout the mortgage term and so would still owe £100,000 at the end.
Borrowers are supposed to set up a savings plan to run alongside the loan and eventually pay the capital debt.
But interest only deals are risky. If your savings plan does not perform well – or you fail to set up an appropriate scheme – you could lose the roof over your head.
The big attraction of interest-only mortgages is the lower monthly payments. For example, if you borrowed £100,000 over 25 years at 4% on an interest-only deal, you would pay £333 a month. A repayment mortgage would cost £528 a month.
The lower payments can make a big difference to your monthly outgoings. But interest-only mortgages are not cheaper in the long run because you do not pay back any of the capital debt as you go along.
So, monthly payments of £333 on a £100,000 interest-only mortgage would bring the total interest payments to £99,900 over 25 years. The borrower would then have to pay back the original £100,000, so the total mortgage cost is £199,900. But the total cost of the repayment mortgage at £528 a month for 25 years, is £158,400 – almost £50,000 less.
So if you think you can save money with an interest only loan, think again.
Naomi Caine was editor of The Sunday Times Money section for six years before she moved out of London to bring up a young family. She now juggles two children with a freelance career, and has written for a variety of publications, including MSN, Yahoo, The Times, The Sunday Times, Which? Money, Money Week and The Sunday Herald.