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When you take out an interest only
mortgage the repayments only pay off the interest accrued on the
original capital of the mortgage. Interest only is repaid in monthly
instalments, not the actual loan itself. This results in lower monthly
payments, giving you extra money with which to buy a property that would
not be possible if you were on with other mortgage products. However at
the end of the mortgage term you will still owe the original capital.
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With an interest-only mortgage,
the payment you make to the mortgage lender each month comprises just
the interest you owe them for that month. So you are not paying off any
of the capital you owe.
When you take out an interest-only mortgage, you are supposed to also
make a monthly payment into an Individual Savings Account, endowment or
other investment. The hope is that the investment will then generate
sufficient returns to pay off the capital sum you still owe at the end
of the mortgage term.
With high house prices, this is
the only way some people have managed to afford to buy property. When
taking out an interest-only mortgage and just paying the interest, they
are relying on their property going up in value, being able to sell it a
few years down the line for a profit, and then buying a property with a
repayment mortgage.
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There are a number of risks here.
Firstly, house prices are not guaranteed to go up, and could even fall.
Secondly, many people sort out their mortgage and then forget about it.
If you never get around to converting your interest-only mortgage to a
repayment-type, and you have no investment fund building up, there is a
very real risk that you may get to the end of your 25 year mortgage term
still owing all of the capital initially borrowed and with no way of
repaying it.
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