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."

Voices
Barn owls are among species that could be affected
charity appeal
News
Sarah Silverman (middle) with sister Reform Rabbi Susan Silverman (right) and sister actress Laura Silverman (left) at Jerusalem's Western Wall for feminist Hanuka candle-lighting ceremony
peopleControversial comedian stages pro-equality Hanukkah lighting during a protest at Jerusalem's Wailing Wall
Arts and Entertainment
The Bach Choir has been crowned the inaugural winner of Sky Arts’ show The Great Culture Quiz
arts + ents140-year-old choir declared winner of Sky Arts' 'The Great Culture Quiz'
Sport
After another poor series in Sri Lanka, Alastair Cook claimed all players go through a lean period
cricketEoin Morgan reportedly to take over ODI captaincy
PROMOTED VIDEO
Finacial products from our partners
Property search
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

    Carlton Senior Appointments: Private Banking Manager - Intl Bank - Los Angeles

    $200 - $350 per annum: Carlton Senior Appointments: Managing Producer – Office...

    Carlton Senior Appointments: San Fran - Investment Advisor – Ind Advisory Firm

    $125 - $225 per annum: Carlton Senior Appointments: San Fran - Investment Advi...

    Sheridan Maine: Commercial Finance Manager

    Up to £70,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

    Sheridan Maine: Regulatory Reporting Accountant

    Up to £65,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

    Day In a Page

    Homeless Veterans appeal: 'You look for someone who's an inspiration and try to be like them'

    Homeless Veterans appeal

    In 2010, Sgt Gary Jamieson stepped on an IED in Afghanistan and lost his legs and an arm. He reveals what, and who, helped him to make a remarkable recovery
    Could cannabis oil reverse the effects of cancer?

    Could cannabis oil reverse effects of cancer?

    As a film following six patients receiving the controversial treatment is released, Kate Hilpern uncovers a very slippery issue
    The Interview movie review: You can't see Seth Rogen and James Franco's Kim Jong Un assassination film, but you can read about it here

    The Interview movie review

    You can't see Seth Rogen and James Franco's Kim Jong Un assassination film, but you can read about it here
    Serial mania has propelled podcasts into the cultural mainstream

    How podcasts became mainstream

    People have consumed gripping armchair investigation Serial with a relish typically reserved for box-set binges
    Jesus Christ has become an unlikely pin-up for hipster marketing companies

    Jesus Christ has become an unlikely pin-up

    Kevin Lee Light, aka "Jesus", is the newest client of creative agency Mother while rival agency Anomaly has launched Sexy Jesus, depicting the Messiah in a series of Athena-style poses
    Rosetta space mission voted most important scientific breakthrough of 2014

    A memorable year for science – if not for mice

    The most important scientific breakthroughs of 2014
    Christmas cocktails to make you merry: From eggnog to Brown Betty and Rum Bumpo

    Christmas cocktails to make you merry

    Mulled wine is an essential seasonal treat. But now drinkers are rediscovering other traditional festive tipples. Angela Clutton raises a glass to Christmas cocktails
    5 best activity trackers

    Fitness technology: 5 best activity trackers

    Up the ante in your regimen and change the habits of a lifetime with this wearable tech
    Paul Scholes column: It's a little-known fact, but I have played one of the seven dwarves

    Paul Scholes column

    It's a little-known fact, but I have played one of the seven dwarves
    Fifa's travelling circus once again steals limelight from real stars

    Fifa's travelling circus once again steals limelight from real stars

    Club World Cup kicked into the long grass by the continued farce surrounding Blatter, Garcia, Russia and Qatar
    Frank Warren column: 2014 – boxing is back and winning new fans

    Frank Warren: Boxing is back and winning new fans

    2014 proves it's now one of sport's biggest hitters again
    Jeb Bush vs Hillary Clinton: The power dynamics of the two first families

    Jeb Bush vs Hillary Clinton

    Karen Tumulty explores the power dynamics of the two first families
    Stockholm is rivalling Silicon Valley with a hotbed of technology start-ups

    Stockholm is rivalling Silicon Valley

    The Swedish capital is home to two of the most popular video games in the world, as well as thousands of technology start-ups worth hundreds of millions of pounds – and it's all happened since 2009
    Did Japanese workers really get their symbols mixed up and display Santa on a crucifix?

    Crucified Santa: Urban myth refuses to die

    The story goes that Japanese store workers created a life-size effigy of a smiling "Father Kurisumasu" attached to a facsimile of Our Lord's final instrument of torture
    Jennifer Saunders and Kate Moss join David Walliams on set for TV adaptation of The Boy in the Dress

    The Boy in the Dress: On set with the stars

    Walliams' story about a boy who goes to school in a dress will be shown this Christmas