Interest-only mortgages return to give more flexibility to borrowers

The credit crunch put a temporary end to these once-popular mortgages. But lenders are waking up to rising demand and relaxing their rules
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The Independent Online

The concept is simple: you take out a mortgage but only repay the interest monthly, leaving the capital – the amount you've borrowed – untouched. Meanwhile you have an alternative plan to raise the cash to repay the home loan.

Interest-only mortgages have been hugely attractive in the past to borrowers, not least because if you're not paying off any of the capital, it cuts the cost of monthly repayments.

But the credit crunch appeared to have put the concept to rest. Bear in mind that back in 2006, before the banking crisis, there were 75 lenders eager to agree interest-only loans, according to Moneyfacts' statistics. By 2013 there were just 12, with big lenders such as Nationwide and NatWest publicly withdrawing from offering them.

The building society still steers clear of interest-only. It says: "Nationwide has not offered interest-only mortgages since October 2012. As a responsible lender, the decision was taken due to changes to the market environment and a decline in interest-only mortgage applications."

But the continuing low-interest rate environment we're in is encouraging more people to switch to interest-only. Why? Ian, who has been on interest-only since graduating 15 years ago, says: "I've put the money I would have used to repay the capital into a medium-risk growth fund in an Isa. I reckon my investments will grow to be large enough to pay off my mortgage long before the end of my 25-year mortgage term."

He also says he enjoys more flexibility. "If things are tight one month, I don't make the investment. If I was short on my mortgage repayment by the same amount, the lender would be shouting about it. It leaves me with greater control of my finances."

Lenders have woken up to the increased demand and the number now offering interest-only is 22, almost double the number in 2013. Many are also relaxing their rules slightly, having made them more restrictive in recent years.

"With new borrowing rules coming into place, lenders tightened their criteria, being specific who they lend to and who they offer the interest-only facility to," says Charlotte Nelson of Moneyfacts.

"Alongside this, their interest-only policy was tightened so they no longer offer 100 per cent interest-only mortgages." Instead, many offer a split repayment facility where part of the mortgage is interest-only and part repayment.

Adrian Anderson, of mortgage broker Anderson Harris, says: "Banks in the past would offer interest-only without asking enough questions around how the mortgage was going to be repaid. But many lenders then swung the other way and began making the decision for the borrower regardless of their repayment strategy."

That ruled out people who planned to use the potential future profit from the rising price of their home to sell it, repay the balance, and use the rest to downsize.

But Barclays has recently changed its criteria so that money from selling a main residence can be used to pay back the capital at the end of the mortgage term, a policy Santander already operates.

"But restrictions are still in place that typically mean that the maximum proportion of a property value that they will lend is limited, often to as little as 50 per cent loan to value," warns David Hollingworth of London & Country Mortgages.

"Some lenders top that up with part of the mortgage on repayment, but even then the maximum loan to value caps out at 75 per cent."

In other words, the deals aren't for first-time buyers, only for those with decent equity in their home. For instance, Santander will accept the sale of the property as long as there is at least £150,000 equity in it.

"The reason that the new rules put a focus on interest-only was to prevent borrowers reaching the point where they'd never get round to covering the mortgage and would be forced to sell, particularly where they were simply relying on the growth in property prices," points out Mr Hollingworth. "Nevertheless, interest-only can work well for those that are disciplined in tracking that they remain on plan to repay the mortgage."

Best interests: will it work for you?

Mark Harris, of mortgage broker SPF Private Clients, says: "Banks clamped down on interest-only borrowing as a knee-jerk reaction to lax lending practices, but interest-only does have a place for the right borrower with a considered repayment strategy in place.

"If you are self-employed or have irregular monthly income streams, making a lower monthly mortgage payment will help. It may also help those with bonus-driven remuneration – where it is regular and demonstrable over a period of time.

Interest-only can also suit those with deferred bonus income vesting in the future or large pension pots that allow sufficient tax-free cash to be taken to repay the mortgage. It can also be helpful for those with a joint mortgage where one of you is on a career break – for maternity leave, for example.

"But you'll need a plan for paying off the capital that will have to be acceptable to the lender. If you are planning to downsize, for example, there must be enough equity in the property to enable you to do so. Those hoping to win the lottery or inherit a lump sum from an elderly relative will find that this 'strategy' won't be acceptable to any lender."

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