Interest Only Mortgage

Interest only mortgages allow borrowers to reduce their monthly mortgage payments by only paying interest on the outstanding loan balance.

Interest only home loans are popular ways of borrowing money to buy an asset that is unlikely to depreciate much and can be sold at the end of the loan to repay the capital. For example, second homes, or properties bought for letting to others. In the 1980s and 1990s a popular way to buy a house was to combine an interest only loan with an endowment policy, the combination being known as an endowment mortgage. Homeowners were told that the endowment policy would cover the mortgage and provide a lump sum in addition. Many of these endowment policies were poorly managed and failed to deliver the promised amounts, some of which did not even cover the cost of the mortgage. This mis-selling, combined with the poor stock market performance of the late 1990s, has resulted in endowment mortgages becoming unpopular.

An interest-only loan is a loan in which for a set term the borrower pays only the interest on the principal balance, with the principal balance unchanged. At the end of the interest only term the borrower may enter an interest only mortgage, pay the principal, or (with some lenders) convert the loan to a principal and interest payment loan at his/her option..

Because interest only Mortgages reduce the amount of the payments due to the lender each month, they are a popular vehicle for individuals to finance the purchase of their first home.

Interest only mortgages can help ease the financial burden involved with home ownership, allowing for borrowers to get a foot on the property ladder and switch to a repayment mortgage when it becomes more affordable.

Interest only mortgages are therefore a short-term solution to the high cost involved in borrowing money to acquire property.

However at some point during its term the mortgage should be switched to repayment unless a successful Capital Repayment Vehicle (CRV) is in place.

A CRV is an investment policy designed to produce enough money to repay the balance of an interest only mortgage at the end of its term.

CRVs are usually found in the form of an endowment policy, an ISA-based investment scheme, or a personal pension plan.

Regardless of how the borrower is planning on repaying the capital portion of the loan, a level term assurance policy should be taken out when the interest only Mortgage is established.

A level term assurance policy will pay out a fixed sum upon death of the assured. The amount assured should cover the capital portion of the interest only mortgage.

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