The working of a traditional mortgage involved a borrower paying fully amortised monthly payments to the mortgage lender. This means that a borrower pays an equal amount every month. This is an amount determined on the basis of a calculation done. This calculation derives the amount to be paid every month by the borrower to pay-off the loan in full.
There is usually a specific term which the loan has to be paid off. However, there are now interest only lifetime mortgage that can suit, depending upon one’s financial demands.
Interest only mortgage loans differ from the traditional loan system because they do not require monthly amortised payment on behalf of the borrower. Therefore, only the interest charged is paid, no capital, thus resulting in the balance remaining the same.
The workings of an interest only mortgage are explained below:-
As usual, the period of the loan is predetermined. However, the borrower now has to make a monthly payment only on the income that this loan accrues. There is no need to make a payment towards the principle borrowed whilst paying off the interest. This considerably brings down the amount to be paid by the borrower every month. If the mortgage is pre-retirement then the lender will require some form of repayment; be it an ISA, low cost endowment and in some cases sale of property as a repayment vehicle.
Conversion to traditional mortgage
Given the financial issues dealt to interest only mortgages and low cost endowment policies in the past, the most common form of mortgage is now a capital and repayment mortgage. With endowment shortfalls and even litigation on these insurance policies historical, mortgages have since switched from an interest only basis over to capital and repayment. The capital and repayment route for mortgage repayment will always guarantee the eventual settlement of the loan. This is therefore best suited to the more cautious investors.
The benefits and disadvantages of an interest-only mortgage
An interest only mortgage is beneficial to those people who cannot afford to make fully-amortised payment after having taken the mortgage. It is a comfortable way of renting your home from the mortgage company and paying only the interest till such time that you start earning greater income. However, making interest-only payments does not earn equity for the home. Also, once the loan is converted to a traditional mortgage, the payments to be made by the borrower may become considerably higher than the amount that they would have had to pay through the traditional method of payment. The longer this period is left the higher the payments are going to be.
The FCA has recently clamped down on mortgage lenders offering interest only mortgages, especially to first time buyers. But interest only mortgages can still have a part to play when times of financial strife are upon us. Evidence of this could on such events as divorce or loss of employment. This should only be a temporary measure and reversion back to a repayment basis should follow as soon as possible once financial redress has been sanctioned.
Retiree Interest Only Mortgages
The talk above is definitely about standard interest only mortgages, but there are other products on the market. For retirees there are also interest only mortgages called lifetime mortgages. Lifetime mortgages work differently because you only make a repayment at the end of your life or when your main residence is no longer property, but a rental or care facility.
With interest only thrown into the mix you make a monthly payment like you do with traditional mortgages of this type. Yet, you are not kept to a 10 year repayment period. There are several different products on the market for retirees. It just depends on what you are most interested in with regards to your home and as a retiree. The interest only mortgage can guarantee a little inheritance is left for your beneficiaries, where other products are not necessarily able to make this same guarantee.
For example drawdown lifetime mortgages provide you with an account you withdraw from as you need it. Interest only accrues to the amount you use. If you do not use all the equity and your home appreciates there is an inheritance left. On the other hand, if the house depreciates and reaches the amount you used plus interest compounded there is no guarantee of inheritance.
Luckily the FCA is regulating the industry because you can include an inheritance clause to guarantee a certain amount of equity remains untouched. This has to be completed before you close on the lifetime mortgage or you won’t be able to validate it.