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Interest-only mortgages are losing popularity, according to new research by long-term lender April Mortgages.
It says the number of outstanding home loans has fallen 70 per cent over the past decade to 664,000, representing just 8 per cent of all home loans.
Interest-only mortgages mean that borrowers only pay the interest each month and the loan amount remains the same.
They must then find a way to pay off the mortgage in full at the end of the term, usually through savings or investments, an inheritance, or selling the home.
Assuming the decline continued at the same pace, by 2034 there would be only 184,000 mortgage loans outstanding, just 2 percent of the mortgage market.
According to the research, over the past 10 years, more than 1.5 million interest-only loans have come due, with borrowers either paying off their mortgage in full or opting for a repayment arrangement.
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Out of favor: April Mortgages estimates the number of interest-only mortgages could fall below 200,000 in the next 10 years
This means figures have fallen by 11 per cent a year on average, causing the interest market to shrink to just over a quarter of its size 10 years ago.
Interest-only mortgages were once much more popular than they are today, but stricter regulations after the financial crisis meant banks were able to grant far fewer mortgages and imposed stricter criteria on applicants.
Rachael Hunnisett, director at April Mortgages, said: “Part of this reduction in the market will be driven by increased regulatory oversight which has played a crucial role in ensuring responsible lending practices, along with lenders reducing or withdrawing interest-only products for align with your own desires to lend.
‘Our projections based on market trends over the past decade reveal that interest-only mortgages could represent as little as 2 per cent of all outstanding residential mortgages by 2034.
“This calls into question the future of interest-only mortgages and risks limiting consumer choice at a time when borrowers have demonstrated their ability to meet their payment commitments.”
Can interest-only mortgages be useful?
After 2008, some people view interest-only mortgages as synonymous with irresponsible lending and reckless borrowing.
However, while it will not be suitable for everyone, if used responsibly, an interest-only mortgage can be a temporary lifesaver or even a profitable financial tool.
Most buy-to-let investors use interest-only mortgages to safeguard their cash flow each month, giving them quick access to funds they can reinvest in their portfolio.
It may also be one of the reasons we didn’t see a big increase in foreclosures among homeowners when interest rates rose in 2022 and 2023.
For homeowners who are worried about increasing their monthly payments, for example those who locked in a low rate before 2022 and are now remortgaging, an interest-only deal may provide some breathing room.
However, if they do not have a plan to repay the loan, this should only be used as a temporary measure and they should return to a repayment mortgage as soon as they can.
| Year | Number of outstanding interest-only mortgages |
|---|---|
| 2013 | 2,188,000 |
| 2023 | 664,000 |
| 2024 | 590,960 |
| 2025 | 525,984 |
| 2026 | 468,099 |
| 2027 | 416,608 |
| 2028 | 370,781 |
| 2029 | 329,995 |
| 2030 | 293,695 |
| 2031 | 261,388 |
| 2032 | 232,635 |
| 2033 | 207,045 |
| 2034 | 184,270 |
Interest-only mortgages can also be a useful tool for someone who relies heavily on uneven income streams, such as commission or bonus payments.
A £200,000 mortgage repaid over 20 years with a repayment mortgage at a rate of 4.5 per cent will cost £1,265 a month. A £200,000 interest-only mortgage on the same basis would cost £749 a month.
Of course, the fact that someone is not paying the debt will be a concern for many.
But most mortgages allow borrowers to make fee-free overpayments each year without incurring early repayment charges.
This means that a sensible borrower can still reduce debt over time with one-time payments.
Overpayments are usually limited to 10 percent of the mortgage amount each year, but sometimes they can be more.
“The interest rate shock that many borrowers are currently experiencing as their fixed mortgage comes to an end highlights why interest-only deals should continue to be widely available to borrowers,” Hunnisett added.
‘Homeowners facing a sharp increase in their mortgage payments may not want to lock in a higher rate or have to extend the term of their mortgage to keep costs down.
‘An interest-only mortgage may be a viable solution in this situation, as it returns control to the borrower and provides greater certainty and security of repayment.
“While interest-only mortgages are not for everyone, they can be advantageous for older homeowners with considerable equity, as well as first-time borrowers who want to improve their affordability.”
Expert: Rachael Hunnisett, director at long-term lender April Mortgages
Who can get an interest-only mortgage?
The challenge for borrowers seeking an interest-only mortgage for their own home is that they are subject to much stricter lending criteria.
Mortgage lenders will want to know from the beginning how you plan to pay the mortgage. This may include the sale of the home, the sale of a second property, a lump sum pension, investments or savings.
The loan-to-value ratio of the mortgage will also influence the lender’s decision. There is usually a maximum loan-to-value ratio above which a lender will not agree to pay interest only.
Borrowers typically need to put down a 25 per cent deposit, although there are lenders willing to exceed this.
Some lenders also require you to have a minimum income, which can be £20,000 or £50,000, £75,000 or even £100,000. But other lenders have no minimum income requirements.
In this week’s Navigate the Mortgage Maze column, broker David Hollingworth shared his advice with a reader who was wondering whether they should switch to an interest-only mortgage.
“Even if the stricter criteria can be met, I think you should think very carefully before moving to an interest-only system,” Hollingworth said.
‘The longer you go without making a dent in the mortgage, the harder it will be to make the payment.
‘In the past, this has 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 reduce your monthly payments, it is not a cheap mortgage and you will pay a lot more interest over that period.”
According to Hollingworth, there are also alternative options that borrowers should think about.
He added: ‘Alternative options could include taking just part of the interest-only mortgage and paying the remainder to continue to reduce the bulk of the mortgage each month.
‘You could also maintain the mortgage on a repayment basis, but consider the possibility of extending its term.
‘That will still cost you more in interest, but will help mitigate the increase in your mortgage payment.
“You may also consider making excess payments in the future, or shortening the term again, to reduce your overall mortgage interest bill.”
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