Mortgages. An interest only mortgage: it could cost you more

Over 200,000 homebuyers in London during 2005 took out an interest-only loan according to the Council of Mortgage Lenders (CML). None of whom had a repayment vehicle in place and of these, 60,900 were first-time buyers.

There are no figures available for the total number of homebuyers with interest-only loans. However, figures for new interest-only house purchase loans have been running at between 10 and 20 per cent for all new first-time buyers over the past 10 years, and roughly the same for other homebuyers.

With more than half of all mortgages now arranged through an intermediary, mortgage brokers could be in the firing line for claims of mis-selling if the homebuyer's loan reaches maturity and there is not enough cash to pay off the loan.

The CML is keeping close tabs on the situation and has set up a shortfalls working group to look into ways of encouraging consumers to act now to address any shortfall on interest-only mortgages."

We are suggesting that when a mortgage comes up for review, for example, when it reaches the end of a concessionary rate, then it would be prudent to check on how the borrower intends to repay the loan," said a spokesperson for the CML.

Using an interest-only mortgage will keep your monthly payments down until you can afford the higher monthly payments of a repayment mortgage. But because you're not paying anything off the amount you owe, you will probably end up paying more interest in the long run. Interest only mortgages are a high-risk strategy that could come back to haunt advisers that set up the arrangement. An increase in interest rates could also hit these clients hard as they would have no fall-back option of reverting to an interest-only mortgage. Simply enough, to combat the issue clients must be told that if they can not afford to pay for a mortgage, don’t take one out. Here’s what you need to know. With an interest-only mortgage your monthly payments only cover the interest on the loan and do not actually pay off the loan itself. If you take this option you will need to make separate arrangements to pay off the loan when the mortgage ends. You can make your arrangements through your lender – but it isn’t compulsory. If you don't arrange the funds at the end of the mortgage you may very well lose your home. Essentially, the money you pay to the interest only mortgage goes no where – you may as well rent. You will have a substantial amount of time (depending on the actual agreement) to save regularly in order to make payments into a savings or investment scheme in order to build up a lump sum to pay off the mortgage when the time comes. However, the returns offered by banking or building society accounts are usually too low to be used to pay off the amount borrowed. Instead, it is common to accept some risk in the hope of a higher return by choosing schemes where returns are linked to the stock market. Although the risk is with these stock market linked schemes, there is no guarantee that your money will grow enough to pay off the mortgage in full by the end of the mortgage term. Another option is to change to a repayment mortgage later. This might be a suitable option if your earnings are low now but are expected to be much higher in future. Using a lump sum from somewhere else such as an inheritance or selling something such as another property or a business is another option and is also a risky one. You need to be sure that the inheritance will materialize and think about what would happen if your business was to fail.

Selling the property to pay off the loan is probably your last option. This is suitable only if you won't need to live in the property such as if it is a buy-to-let property or a second home, or you are buying something cheaper. Whatever plans you make to repay your mortgage, remember to review them from time to time to make sure that they are still on track. In the first place, interest only loans should be a last resort and should always only borrow what you are guaranteed to be able to pay back.