How Interest-Only Loans Are Helping People to Buy Mortgages

With the difficulties these days in getting mortgages and the high costs associated with obtaining a mortgage, this article looks at the interest only option loans which are enabling people to gain a mortgage and the advantages and disadvantages associated with this option.

Confidence in theUK housing market has rebounded since the 2008 financial crisis, with financialinstitutions lending out more mortgages with increasingly competitive terms andconditions. According to the Telegraph, this rebound is partly attributable tothe return of interest-only mortgages. Interest-only mortgages allow forgreater flexibility than traditional repayment mortgages; however they do comewith a set of risks and conditions that potential homebuyers should be aware ofbeforehand. While these loans allow individuals to buy mortgages that arebetter suited to their needs, such loans also require greater planning andfiscal responsibility on the part of the borrower. This article will look atwhat interest-only mortgages are, what their advantages and disadvantages are,and how individuals should manage their finances if they choose to take out aninterest-only mortgage.

Interest-only vs.Repayment

With the morecommon repayment type of mortgage, borrowers make monthly payments that go towardpaying down both the capital of the loan as well as the mortgage. Interest-onlymortgages, however, are slightly different, as they allow borrowers to pay onlythe interest of the mortgage each month. The capital will still need to be paiddown, but not for a certain period (typically two to five years), during whichonly the interest needs to be paid.

Advantages ofInterest-only Mortgages

The advantage ofan interest-only mortgage is that, at least for the interest-only period,monthly repayments tend to be much smaller than they would be for a repaymentmortgage. These smaller payments allow individuals to save money during theinterest-only period, money which can then be used to pay down the capital ofthe loan later on. As such, for those who are looking to buy a house today, butare not quite yet able to make the large monthly repayments that a repaymentmortgage demands, then an interest-only mortgage could be ideal.

Disadvantages ofInterest-only Mortgages

Interest-onlymortgages come with a number of disadvantages, however, that borrowers shouldbe aware of. In many instances, borrowers invest their savings during theinterest-only period in stock funds or Isas in order to put the money they makefrom these funds towards the capital of their mortgage later on. If these fundsdo not perform well, however, borrowers may find it difficult to repay thecapital of their loan. Additionally, getting approved for an interest-onlymortgage tends to be much more difficult than it would be for a repaymentmortgage. Most banks will demand a much higher deposit for an interest-onlyloan than they would for other types of loans. While interest-only mortgagesare making a comeback, it is important to know that they are still consideredhighly risky for lending institutions, thus many banks refuse to grant themoutright. Finally, while the monthly payments for an interest-only mortgage arelow to start with, over the life of the loan borrowers will often end up payingmore in interest since they are still paying the interest on the full capital.

How to manage aninterest-only mortgage

Paying down aninterest-only mortgage requires prudent financial planning. As mentioned, manyborrowers choose to invest money in stocks or Isas which they then put towardsthe capital of their mortgage when the interest-only period ends. While this iscertainly a wise decision, borrowers should have a backup plan in case thoseinvestments do not perform as well as expected. While the low initial monthlypayments are attractive to many borrowers, being realistic about whether one’sown income will be sufficient to cover the monthly repayments once theinterest-only period ends is imperative. Additionally, since the entire capitalwill still be owed during the interest-only period, it is a good idea toprotect one’s family from having to repay that capital in the event of one’sdeath. As such, taking out a life insurance policy that covers the same term asthe mortgage can help safeguard family members from having to pay down theentire mortgage should the borrower pass away before the end of the loan’sterm.

An interest-onlymortgage offers great financial flexibility and lower monthly repayments duringthe first few years of the mortgage term, making it an attractive option forthose who want to buy a mortgage today but do not yet have the financial meansof making large monthly repayments. These mortgages, however, are highly riskyand come with strict approval requirements, meaning borrowers need to be ableto plan for their financial future for years ahead.

Reference

‘Return of theinterest-only mortgage.’ Telegraph.telegraph.co.uk/finance/personalfinance/borrowing/mortgages/10254687/Return-of-the-interest-only-mortgage.html

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