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Our five-year fixed mortgage deal is coming to an end in May next year and we need to start thinking about remortgaging.
As interest rates are now higher, we will pay around £400 more each month from May if we do a deal now. That’s an extra £4,800 a year.
My wife and I are worried about the additional cost, since since we took out the last mortgage we have had two children, which is also becoming quite expensive.
We were wondering if moving to an interest-only mortgage for a period of time might be a good way to reduce our overall costs. We would pay the mortgage balance again when our finances improved.
Our outstanding mortgage is currently over £300,000 and we believe we have between 30 and 40 per cent equity in the property.
My first question is, how easy is it to get an interest only mortgage? Will we pay a higher fee for doing so? And are there any disadvantages we should be aware of other than the fact that we won’t actually be paying any of our mortgage balance?
What will we need to tell lenders so that Would you agree to give us an interest-only mortgage?
Mortgage help: In our weekly column Navigate the Mortgage Maze, broker David Hollingworth answers your questions
David Hollingworth replies: You will no doubt have enjoyed a considerable benefit by locking in a low rate five years ago, which will have given you protection against the volatile rates of recent years.
Mortgage rates are now substantially higher than when you agreed to your current deal, even though they have dropped from their recent peak.
You have some time to consider the range of options available to you and how best to mitigate any increases, but it makes sense to start three or four months before the current deal ends.
Some have used the low fixed rate period to overpay and try to reduce the balance more quickly, but that’s easier said than done, especially with two new additions to the family.
That will have affected your disposable income and will therefore also influence your mortgage lender’s affordability calculations. Higher costs, such as childcare costs, which can be particularly significant, may reduce the amount they will be willing to offer.
An interest-only mortgage will lower your monthly payment, which could help you with your monthly expenses. However, the key difference is that it will not reduce your mortgage balance.
That might be something that would help you, as a short-term measure. The Mortgage Letter made possible a temporary switch to interest only to help borrowers struggling with the cost of living crisis.
The Charter is a package of government measures, introduced in July 2023 when mortgage rates soared.
Lenders offer interest-only mortgages and although they may sometimes carry a slightly higher interest rate, many will allow interest-only loans at the same rates as repayment mortgages.
> What’s next for mortgage rates in 2024 and how long should they be fixed for?
Who can get an interest-only mortgage?
Interest-only mortgages often carry a number of stricter eligibility requirements and criteria.
For example, several major lenders will expect borrowers to have a minimum income level to qualify.
That could often require a minimum income of £75,000 for one applicant, or a total of £100,000 or more for joint applicants.
Most lenders will have a maximum percentage of the property’s value, called the loan-to-value (LTV), that they will offer for interest-only applications.
The longer you go without making a dent in your mortgage, the harder it will be to switch to payment.
It has a good level of capital, which should make interest just a possibility. However, the lender will also want to know how you intend to pay off the mortgage when the term ends.
Of course, you can choose to return to a repayment mortgage when your finances allow, but the lender will still need to make sure you have a plan to repay the loan if you don’t.
It could be an investment vehicle that you contribute to along with the mortgage, which the lender will want to substantiate, or it could potentially be the sale of the property itself.
However, in the latter case the lender usually imposes a stricter LTV and expects a minimum level of equity in the property.
This varies between lenders and can also depend on where your property is located, but can often be in the region of a capital cushion of £200,000 to £300,000.
Is an interest-only mortgage your best option?
Even if you can meet the stricter criteria, I think you should still think very carefully before switching to interests only.
The longer you go without making a dent in your mortgage, the harder it will be to switch to payment.
In the past, this resulted in borrowers having to extend the life of the mortgage or even facing the prospect of having to sell the property to pay off the balance.
Although it will lower your monthly payments, it’s not a cheap mortgage and you’ll pay a lot more in interest over that period.
For example, taking out a £300,000 mortgage, for a 25-year term, with an interest rate of 4.50 per cent would cost you £1,667.50 per month.
On an interest-only basis, that would be reduced to £1,125 per month, but you would incur a further £137,250 in interest over the life of the loan, on top of leaving the balance.
Alternative options could include taking only part of the interest-only mortgage and paying the rest to continue to pay off the majority of the mortgage each month.
One could also think of another measure adopted by the Mortgage Statute, and maintain the mortgage under an amortization regime but consider extending its term.
That will still cost you more in interest, but it will help mitigate the increase in your mortgage payment.
Then, you may also consider making overpayments in the future, or shortening the term again, to reduce your overall mortgage interest bill.
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