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The pitfalls of interest only mortgages
The proportion of home buyers taking an interest only mortgage is steadily increasing. The reason is clear. Interest only mortgages reduce the monthly repayment as borrowers only pay off the interest and are not making any reduction in the capital they have borrowed.
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In the first three months of 2002, 9% of all new mortgages were interest only but by the last three months of last year, this had risen to 23%. And amongst first time buyers the rise was from 6% to 15%. (Source: Council of Mortgage Lenders)
It's a reflection of people trying to minimise their fixed costs in order to preserve their lifestyle - they still want their nice cars, nights out and holidays abroad. But borrowers' ( personal secured loans ) reluctance to cut back a bit on their life style spending, combined with steadily rising house prices, could be storing up problems for them in the future. If they're not chipping away at the capital now, how exactly are they going to repay it?
Many lenders are now becoming much stricter by insisting that there is a viable repayment vehicle in place before agreeing an interest only mortgage. These repayment vehicles could be the forecast tax-free cash from a pension, or an ISA or some other regular savings or investment scheme. The danger is that having got the mortgage, they subsequently cancel their savings scheme.
If that happens, when retirement arrives accompanied by the impending repayment of their ( life assurance ) mortgage capital, they'll be faced with having to sell their house and down size in order to free up sufficient money to repay the mortgage. And that's a scenario that lenders are anxious to avoid.
Twenty years ago interest only mortgages were the norm with endowment policies being ( life assurance ) used to underwrite the capital repayment. But as we all now know, returns on endowment policies are not high as many assumed they would be and they're certainly not the "guaranteed " repayment solution that twenty years ago many had assumed.
Your home may be repossessed if you do not keep up your repayments on a mortgage or any debt secured on it. Security by way of a charge on your home may be required.