Switching to an interest-only mortgage: more borrowers asking the question

Switching to an interest-only mortgage is a question more borrowers are asking, as they come off cheap 5-year fixes, mortgage experts told Newspage.

However, advisers warn that strict lending criteria and the need for a credible repayment strategy mean interest-only mortgages are not suitable for, or available to, everyone.

Experts suggest that extending the mortgage term, making overpayments or shopping around for a more competitive deal could provide more sustainable ways to reduce monthly costs.

Can I switch to an interest-only mortgage?

Only with enough equity and a credible plan to repay the capital, brokers say. Many ask, but few go on to switch.

Rohit Kohli, Senior Mortgage Adviser at Romsey-based The Mortgage Stop, said: “We’re seeing a change in conversations. A few more clients are asking about interest-only or part-and-part, and it comes down to the cost of living.

"People are bracing for rises of £200 to £500 a month and want to stay afloat. Far fewer actually switch.

"Take a client with a £265,000 repayment mortgage on a £300,000 home and 33 years left. Moving from 2.9% to 5.15% takes their payment from about £1,040 to £1,390 a month.

"Interest-only would be about £1,140, a saving of roughly £255. But it isn’t an option, because at nearly 90% loan-to-value they don’t have the equity lenders require. Even if they did, after a 3-year fix they’d still owe £265,000, against about £255,000 on repayment.

"Interest-only isn’t for anyone without a robust repayment plan. Relying on selling the home is risky, especially with the risk of negative equity, or if you think you will have no room to overpay.

"Extending the term, using savings or part-and-part can be better options.”

Craig Fish, Director at London-based Lodestone Mortgages, commented: “I’m not really seeing a rush to interest-only among my clients coming off cheap 5-year fixes.

"The question comes up, but asking about it and qualifying for it are two different things. Interest-only can be a solution for the right borrower, but there are lender criteria to meet first.

"A lender will want to see enough equity in the property and a credible plan for repaying the loan at the end of the term, whether that’s a sale, downsizing or investments.

"Hoping things get better isn’t a plan. If you can show that, it’s a reasonable option. If you can’t, it isn’t on the table.

"The bigger mistake I see is borrowers simply accepting whatever their current lender offers when the fix ends, without checking the rest of the market.

"A product transfer is easy, but easy isn’t the same as right, and a whole-of-market search can sometimes take enough off the monthly payment that changing how you repay the mortgage never needs to come up at all. Look at every option before you sign anything.”

Can I switch to interest-only temporarily?

Yes. Under the government's Mortgage Charter, borrowers who are up to date with their mortgage payments can ask their lender to switch them to interest-only for six months, or to extend their mortgage term.

This can happen without a new affordability check and without it affecting their credit score.

Each option is available on a one-off basis from lenders signed up to the Charter. The capital still has to be repaid, so monthly payments will be higher once the six months end than they would otherwise have been, and the mortgage will cost more overall.

A permanent switch to interest-only is different: it needs a full affordability assessment and a credible plan to repay the capital.

How much does switching to interest-only save?

On a £250,000 mortgage at 5% over 25 years, interest-only saves about £419 a month, but the full £250,000 is still owed at the end.

Nouran Moustafa, Practice Principal & IFA at Roxton Wealth, said: “The mortgage payment shock is real. Borrowers coming off five-year fixes at 1% or 2% are discovering that the same mortgage can now cost hundreds more every month. Interest-only is understandably attractive, but there's a catch.

"On a £250,000 mortgage at 5% over 25 years, repayment costs around £1,461 monthly. Interest-only costs £1,042, saving £419 a month.

"But after 25 years, the interest-only borrower still owes £250,000! Lenders generally require sufficient equity, affordability and a credible repayment strategy. Part-and-part can offer a compromise.

"For someone facing temporary financial pressure, interest-only could provide breathing space, subject to lender approval. My concern is borrowers confusing lower payments with greater affordability.

"Interest-only can buy time, but it doesn't repay the debt. A mortgage repayment strategy based entirely on hoping property prices rise isn't a strategy. It's a gamble with your home.”

Ranald Mitchell, Director at Norwich-based Charwin Mortgages, commented: “Interest-only is becoming a genuine escape valve for borrowers coming off 5-year fixes at 1% or 2% and facing a huge jump in monthly payments.

"For some, switching all or part of the mortgage to interest-only can reduce the payment enough to keep the mortgage affordable.

"The catch is that the debt does not reduce. Lenders will usually want a credible repayment vehicle, sufficient equity and a clear exit strategy.

"This could be downsizing, investments or pension funds. Part-and-part can be a useful compromise because it lowers the monthly cost while still repaying some capital.

"Interest-only can be sensible as a temporary bridge, but it should never be used to disguise an unaffordable mortgage.

"The right question is not just how much it saves today, but how the capital will ultimately be repaid.”

What should borrowers try before interest-only?

Advisers say extending the mortgage term can often reduce monthly payments more easily than switching to interest-only mortgages.

Stephen Perkins, Managing Director at Norwich-based Yellow Brick Mortgages, said: "Coming off a five-year fix at 1% or 2% and refinancing at today’s rates can create a very real payment shock.

"Before moving to interest-only, simply extending the mortgage term can often be the easier way to reduce the monthly payment, subject to the borrower’s age and how much term is already remaining.

"Interest-only or part-and-part can reduce payments further, but lender choice is generally more restricted and there needs to be a credible plan for repaying the capital.

"If that plan is simply hoping rates will be lower later, the borrower risks turning today’s affordability problem into tomorrow’s debt problem.

"For anyone still fortunate enough to be on a very low fixed rate, overpaying now where affordable can also be one of the best preparations for remortgage, reducing the balance before the higher rate arrives."

Ross Lacey, Director at Rayleigh-based Fairview Financial Management, said: "We've been speaking to our clients on 5-year fixes for a while, managing their expectations in what's likely to come when they move onto a new deal.

"Interest-only is something we discuss where appropriate, but there are also other levers that can be pulled.

"Extending the mortgage term, or making a strategic overpayment to get down to a lower loan-to-value can both help reduce the monthly payments from what they might have been, softening the blow.

"Interest only mortgages tend only to be available to those with higher equity in their property, and higher income earners. However there are some lenders and options for those that aren't."