Finance

Pitfalls of interest only mortgages

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Interest only mortgages are loan products whereby the borrower is expected to pay interest on the amount borrowed only.

They seem attractive and as a great option to finance home ownership. However, there is more to them than meets the eye. The estimated number of borrowers with outstanding interest only mortgages stands at 3 million. Another 1 million people were facing the possibility of having their homes being repossessed due to failure of paying off their interest only mortgages.

MMR

The following rules are among tough conditions enforced by the Mortgage Market Review (MMR) in the year 2014:

Actions to be taken by the lender before awarding the borrower with the loan:

Assessing the ability of the borrower (or his guarantor) to pay the amounts of the loan due. They should be able to demonstrate this and the transaction will not be entered into if they fail to meet this criterion.

Assessment of the customer’s ability to repay both the interest on the principle and the capital, over the mortgage term.

Upon clear understanding of the credible repayment strategy, the lender may advance the interest only mortgage to the borrower. This applies when the borrower has the potential to repay the expected accrued interest as well as the capital.

It will also be a challenge for the borrowers of interest only mortgages to get financing through additional funding. This is because although they have paid off the interest on the amount borrowed, they still owe the lender a large amount of the principal. Due to this, they are ‘held prisoner’ and bound by this loan during the mortgage term.

Additionally, retirees face a challenge as the lenders tend to be biased towards them. This is because their repayment options are limited. Some have been forced to use the capital tied up in their homes to repay the amount owed for the interest only mortgage.

MortgageUncertainty about future house prices makes interest only mortgages a potential trap. When there is no substantial increase in the value of homes, it makes it hard for the borrower to access equity release products. The other option, which is not desirable, is to downsize. This is something hard to do, especially if the home is cherished by the family.

Interest only mortgages are not tailored for the mass market. Therefore, if you are considering it as a source of funding, you have to research if you fit the criteria. If your monthly income stream is irregular or if you are unemployed, you will possibly not have the capacity to repay the amounts due within the mortgage term. However, if you have a substantial amount of pension or are employed and earning bonuses, you may fit the bill and stand a chance to be awarded with this loan. However, do keep in mind that having an interest only loan will mean that your chances of securing another deal will be limited. This is an option to be considered only if you do not mind being tied up for the period of the mortgage term.