The age of interest-only mortgages is over

Interest-only mortages were enormously popular in the dizzying heights of the property boom. Now they are all but extinct. Ruth Jackson explains why.

If you've got an interest-only mortgage (the sort where you make interest payments every month but leave the capital part of your debt untouched) the Financial Services Authority (FSA) is worried about you. It believes that over a million people who were sold interest-only mortgages between 2005 and 2009 have no actual loan repayment plan.

It used to be that lenders wouldn't give interest-only loans without some evidence that borrowers had some kind of savings plan in place. But it seems many didn't bother with this bit in the dizzying heights of the housing boom. And borrowers have been equally lax about saving up. "Borrowers need a plan to repay the capital that does not rely on house-price inflation or unrealistic intentions to downsize to a smaller property at the end of the term," warns the FSA.

The FSA believes this problem could really explode between 2024 and 2033, when interest-only mortgage deals given out in the boom reach the end of their term. But the problems could begin sooner than that.

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The first thing to worry about is negative equity, which you're more likely to hit if you never reduce your loan than if you do. That's a major problem if you want to remortgage. But even if you aren't in negative equity, it's going to be hard to remortgage an interest-only deal. With low equity levels, you're likely to find there aren't many deals on offer.

You'll be back to looking for a mortgage with what is effectively a fairly small deposit in a market where lenders have become pickier than they were. Worse, with interest-only mortgages disappearing from the market as lenders react to the FSA's concerns, it's likely that the only thing you will be able to get is a repayment mortgage and that's going to bump up your monthly payments significantly.

So what do you do? The best thing, if you can afford it, is to switch to a repayment mortgage immediately. If you think that might be a struggle over your current term, you might extend your mortgage. The monthly payments on a 35-year mortgage will be lower than on a 25-year one, for example. Failing that, as a matter of urgency, set aside whatever you can every month so that when the time comes to remortgage, you'll have a nest egg to add to your equity so that you can apply for a smaller mortgage. It is time to start thinking beyond interest-only.

Ruth Jackson-Kirby

Ruth Jackson-Kirby is a freelance personal finance journalist with 17 years’ experience, writing about everything from savings and credit cards to pensions, property and pet insurance. 

Ruth started her career at MoneyWeek after graduating with an MA from the University of St Andrews, and she continues to contribute regular articles to our personal finance section. After leaving MoneyWeek she went on to become deputy editor of Moneywise before becoming a freelance journalist.

Ruth writes regularly for national publications including The Sunday Times, The Times, The Mail on Sunday and Good Housekeeping among many other titles both online and offline.