These are mortgages where for a fixed time of 25 years you only pay the interest payments on the mortgages. Usually with a mortgage you pay both the interest on the loan plus an amount to reduce the capital.
With an interest only mortgage it means that you need a separate plan to save money so that you can repay the capital on the mortgage at the end of your 25 year period.
The main problem with interest only mortgages is that there is no guarantee that you will be able to pay off the mortgage at the end of your mortgage period.
Advantages of Interest Only Mortgages
- Your monthly repayments will be significantly lower because you are not paying any additional contribution to the mortgage equity.
- It gives you more flexibility to invest in other schemes and get a potentially better return on your investments.
- It could be beneficial for those who expect significant financial outlays in the beginning of their mortgage period (e.g. school fees) but also expect to get increased income in the future.
- It may be the only way for first time buyers to get on the property ladder and keep their mortgage payments affordable.
- Although at the end of the 25 year period you will owe the same as when you started it is worth bearing in mind inflation will have reduced the real cost of housing, making it relatively easier to pay back
Disadvantages of Interest Only Mortgages
- It is quite risky. Your alternative investment scheme may fail to deliver the necessary amount to pay back the loan. If you were to buy a house for £200,000 it is no mean feat to save that up on your own.
- You will pay more over the course of your mortgage term. This is because you keep paying interest payments on the full amount. E.g. You will be paying 5% of £200,000 for 25 years. With an ordinary mortgage you are paying paying the principal. By the end of your mortgage term you will be paying interest on only say £10,000 so it is much cheaper.
- It takes a lot of discipline to save money. It is tempting to think it is easier than it may appear.
- There is no guarantee your income may increase in the future so that you are in a position to pay back the mortgages
- When interest rates increase it has a proportionally bigger effect on your mortgage. (Although at the same time when interest rates fall there will be a proportionally bigger fall