Interest-only puts you on the ladder, but will it bring you crashing down?

'I'm sure the value of my home will rise'

First-time buyers could be forgiven for being a little over-optimistic when trying to get a foot on the housing ladder.

But those applying for a cheap interest-only mortgage who don't have a savings plan in place to pay off the capital in 25 years' time could run into trouble.

Ten days ago, Nationwide tightened its lending policy to ensure that applicants for mortgages make proper provision to cover the capital sum in the future. It insists they must now include full details of the repayment vehicle chosen to pay off the loan, one that should generate a large enough sum in the years to come.

Savings linked to an interest-only mortgage will typically be held in an individual savings account (ISA) or an existing personal equity plan (PEP). But even a tax-free cash chunk of your pension could suffice.

"If the details don't appear on the application, or the figures don't stack up, we can't issue a mortgage offer," says Nationwide's spokeswoman, Tamsin Hemsley.

It says this policy is a response to regulatory changes ushered in last year by the Financial Services Authority (FSA). The new rules insist lenders must ask the borrower for "evidence of intent" that the property's capital value will be paid off in the future.

But other lenders aren't so specific in setting out their lending criteria.

"Most lenders don't ask for proof of savings - and some don't even discuss repayment plans," says Melanie Bien of Savills Private Finance broker.

Nationwide's new rules mean you won't qualify for an interest-only loan if you plan on paying off the capital by relying on an inheritance, or on hopes of a future pay rise.

If you intend to save via bonuses invested in an ISA instead of making regular deposits, you may be required to show Nationwide some proof from your employer that a bonus system is in place.

If you're relying on selling the property in the future in order to pay off the capital, you won't qualify unless you already own a house with £150,000 worth of equity in it, and the mortgage you are applying for is less than 66 per cent loan-to-value. This, in effect, rules out first-time buyers.

However, Nationwide will look favourably on you if you plan to switch to a repayment mortgage in five years' time and will be paying into an equity ISA in the meantime. Nationwide won't be checking up on applicants to see if they're true to their word, though: borrowers could in theory make no provision during this time.

Interest-only loans have been popular with first-time buyers because of the lower initial monthly repayments, Ms Bien says.

She gives the following example: "Taking a 25-year interest-only mortgage of £120,000, at an interest rate of five per cent, costs £500 a month. But the same deal on a repayment basis costs £700 a month."

Ray Boulger, senior technical manager at the broker John Charcol, says that an interest-only deal can make financial sense on a temporary basis: "First-time buyers especially may have more expensive debt they want to clear first, and paying just the interest on the mortgage can enable them to do this.

"Once they have got rid of this debt, they can switch to a repayment loan."

More than a quarter of homeowners now pay for their property with an interest-only mortgage, according to research from Abbey. Of these, some 37 per cent aren't saving anything towards the capital.

Even if you intend to save religiously to pay off your mortgage, Ms Bien stresses that interest-only loans should be a last resort.

"Anyone considering an interest-only mortgage should be aware that whichever investment vehicle they opt for, it may not raise enough cash to pay back the capital at the end of the term," says Bien.

One solution is an interest-only loan that allows penalty-free overpayments. Here, you are not committed to paying a higher monthly sum but can pay in spare cash to whittle away at the capital.

Most lenders allow at least 10 per cent penalty-free overpayments per annum, but check before taking out the loan.

Justin Westcott, a 27-year-old public affairs manager, decided that it was more important to grab the first rung of the housing ladder than to worry about setting aside money to pay for a home in the future.

Two months ago, he bought his first property in Clapham, south London, with an interest-only mortgage from Northern Rock. He is paying a rate of 5.99 per cent and the deal is fixed for three years.

"I am not saving into any investment vehicle at the moment," he says, "but my main concern was getting on the housing ladder.

"The repayments cost me £870 a month, as it is. I've stretched myself to my maximum borrowing capacity - and that was with a 10 per cent deposit from my father."

At the end of the fixed-rate term, Justin intends either to switch to a repayment mortgage or keep the interest-only loan and start saving into an ISA.

"I have no grand plan," he says, "but I'm sure the equity in my home will rise by then - and I'm gambling my salary will go up too."

News
One Direction's Zayn Malik gazes at a bouquet of flowers in the 'Night Changes' music video
people
News
people
News
'Free the Nipple' film screening after party with We Are The XX, New York, America - 04 Feb 2014
news
Arts and Entertainment
Russell Tovey, Myanna Buring and Julian Rhind Tutt star in Banished
tvReview: The latest episode was a smidgen less depressing... but it’s hardly a bonza beach party
Finacial products from our partners
Property search
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Recruitment Genius: Claims Administrator

    £16000 - £18000 per annum: Recruitment Genius: A position has arisen within th...

    Ashdown Group: Development Manager - Rickmansworth - £55k +15% bonus

    £50000 - £63000 per annum + excellent benefits : Ashdown Group: IT Manager / D...

    Recruitment Genius: Security Officer

    £16500 per annum: Recruitment Genius: Applicants must hold a valid SIA Door Su...

    Ashdown Group: Business Analyst - City, London

    £50000 per annum: Ashdown Group: Business Analyst - Financial Services - The C...

    Day In a Page

    The saffron censorship that governs India: Why national pride and religious sentiment trump freedom of expression

    The saffron censorship that governs India

    Zareer Masani reveals why national pride and religious sentiment trump freedom of expression
    Prince Charles' 'black spider' letters to be published 'within weeks'

    Prince Charles' 'black spider' letters to be published 'within weeks'

    Supreme Court rules Dominic Grieve's ministerial veto was invalid
    Distressed Zayn Malik fans are cutting themselves - how did fandom get so dark?

    How did fandom get so dark?

    Grief over Zayn Malik's exit from One Direction seemed amusing until stories of mass 'cutting' emerged. Experts tell Gillian Orr the distress is real, and the girls need support
    The galaxy collisions that shed light on unseen parallel Universe

    The cosmic collisions that have shed light on unseen parallel Universe

    Dark matter study gives scientists insight into mystery of space
    The Swedes are adding a gender-neutral pronoun to their dictionary

    Swedes introduce gender-neutral pronoun

    Why, asks Simon Usborne, must English still struggle awkwardly with the likes of 's/he' and 'they'?
    Disney's mega money-making formula: 'Human' remakes of cartoon classics are part of a lucrative, long-term creative plan

    Disney's mega money-making formula

    'Human' remakes of cartoon classics are part of a lucrative, long-term creative plan
    Easter 2015: 14 best decorations

    14 best Easter decorations

    Get into the Easter spirit with our pick of accessories, ornaments and tableware
    Inside the Kansas greenhouses where Monsanto is 'playing God' with the future of the planet

    The future of GM

    The greenhouses where Monsanto 'plays God' with the future of the planet
    Britain's mild winters could be numbered: why global warming is leaving UK chillier

    Britain's mild winters could be numbered

    Gulf Stream is slowing down faster than ever, scientists say
    Government gives £250,000 to Independent appeal

    Government gives £250,000 to Independent appeal

    Donation brings total raised by Homeless Veterans campaign to at least £1.25m
    Oh dear, the most borrowed book at Bank of England library doesn't inspire confidence

    The most borrowed book at Bank of England library? Oh dear

    The book's fifth edition is used for Edexcel exams
    Cowslips vs honeysuckle: The hunt for the UK’s favourite wildflower

    Cowslips vs honeysuckle

    It's the hunt for UK’s favourite wildflower
    Child abuse scandal: Did a botched blackmail attempt by South African intelligence help Cyril Smith escape justice?

    Did a botched blackmail attempt help Cyril Smith escape justice?

    A fresh twist reveals the Liberal MP was targeted by the notorious South African intelligence agency Boss
    Tony Blair joins a strange and exclusive club of political leaders whose careers have been blighted by the Middle East

    Blair has joined a strange and exclusive club

    A new tomb has just gone up in the Middle East's graveyard of US and British political reputations, says Patrick Cockburn
    Election 2015: Meet the top 12 wacky candidates seeking your vote in May

    Election 2015

    Meet the top 12 wacky candidates seeking your vote in May