Nowadays obtaining an interest only loan on a residential property can be quite challenging, and rightfully so, as given this is likely to be your main home, you wouldn’t want to end up in a position where you are nearing retirement, and still have hundreds of thousands of pounds remaining on your mortgage.
Before the credit crunch of 2007, it was more of a popular trend to take out an interest only loan, as they were made more readily available by the lenders, and interest rates were generally higher, it made the mortgage repayments more ‘affordable’. This has, however, received much more attention from the regulator over the past decade, which has caused lenders to review their interest only policies, in order to make sure that such mortgages are only available to the right type of applicant.
Essentially the lender needs to make sure that there is a valid repayment vehicle in place, so that at the end of the mortgage term (or before), the loan is able to be repaid in full. Typical repayment vehicles would include stocks and shares portfolios, pension lump sums, sale of other properties, and also sale of the subject property itself. For the latter mentioned vehicle, the lender usually has additional caveats, such as a maximum interest only loan-to-value of 50%; minimum equity value of £300k (for example); or a plausible ‘downsizing’ strategy.
Some lenders may have different criteria such as minimum income requirements (typically £75k-100k), or a minimum loan amount of £300k.
The main perceived benefit of interest only lending is from a cash flow perspective. Naturally your monthly mortgage outgoings are going to be considerably less if only servicing the interest on your loan, compared to if having to also pay off the capital on top. Some homeowners may also consider that their additional cash can be put to better use, and provide greater returns, by investing elsewhere. Of course, most investments which provide noteworthy returns come with considerable risk attached.
The drawbacks to such a payment strategy are clear; that there may not be sufficient capital available at the end of the mortgage term in order to pay off the loan. People may also have the best intentions to invest the ‘savings’ elsewhere, however quite often will squander this on personal consumption / retails goods instead, which is going to make it more difficult / expensive to pay off the loan later in life.
It’s also possible to apply for a ‘part and part’ mortgage, where only a proportion of the loan is on interest only, with the remainder being repaid over a certain number of years. Down this route the repayment vehicle requirement still applies, but it does offer some flexibility around cash flow for those who do qualify.
For buy-to-let (BTL) mortgages, the interest only route is more common, and lenders rarely have any issue with this method. In fact, some lenders are unable to offer BTL loans on a repayment basis, as they have concerns that the rental income may not be sufficient enough to cover the higher monthly payments, particularly when applying their stress tests to the rate.
Although we don’t advise regarding mortgage lending for properties overseas, we do however have a lot of clients based abroad looking to purchase in the UK, and so I’ve noticed a different approach to interest only lending in other countries, particularly in the Far East. Instead it is the case that interest only lending is a novel concept, even on investment properties. This may be because they take a much more conservative approach to mortgage lending, and to compensate for this they seem to offer repayment terms well into retirement, and when one applicant is younger than the other, then can use an ‘income weighted average age’ when calculating the maximum term.
That being said, the more financially savvy overseas investor certainly can see the benefit of interest only lending against rental properties, as it can avoid going into a negative cash flow on the investment when taking into account both interest and capital payments, agency fees, service charges, maintenance, and potential vacancy periods.
The UK regulators have clearly made significant efforts to reduce interest only borrowing against one’s main residence, which no doubt is due to the position that some homeowners found themselves in following the 2007 financial crisis, not to mention the underperformance of endowment policies / pension funds, which didn’t end up providing sufficient repayment funds after all.
If you’d like to hear more about the requirements, pros & cons for interest only lending, then don’t hesitate to arrange a consultation with your Capricorn adviser.
YOUR HOME/PROPERTY MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE