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Sunday, June 16, 2013

What should you do if you have an interest-only mortgage?
Nearly half (48%) of all homeowners with interest-only mortgages will be unable to clear the debt when the loan matures, according to research from new city regulator, the Financial Conduct Authority (FCA).
It found that, of the 2.6 million interest-only mortgages that will mature between now and 2041, around 1.3 million homeowners will be unable to pay off the capital. The average shortfall is estimated to be around £71,000.

What is an interest-only mortgage?

As it says on the tin, an interest-only mortgage just requires you to pay the interest charged every month. The idea is that funds should be saved or invested separately into an investment vehicle such as an ISA or an endowment to cover the capital debt, which much be cleared at the end of the term.

But these investments have largely underperformed, leaving a shortfall at the end of the loan term in many cases. And around 10% of interest-only homeowners are not saving into an investment vehicle at all, according to the FCA's new report.

In the past 12 months, this has prompted a clampdown from mortgage lenders when it comes to granting new interest-only loans. Lloyds TSB and Santander tweaked criteria making the deals more difficult to get, while Royal Bank of Scotland and NatWest, the Co-operative Bank and Nationwide and Coventry building societies stopped offering them altogether.

This means the number of interest-only mortgages available has dropped dramatically. When our data team at MoneySupermarket ran some figures, they found there are currently 141 interest-only deals on offer from 17 lenders. But as recently as November last year, there were 211 interest-only deals offered by 27 lenders.

But what should you do if you already have an interest-only deal and are worried about clearing the debt when it matures? Here are your options.

Switch to a repayment mortgage

The ideal solution is to switch to a repayment mortgage with your current lender, although you would need to be able to afford the increase monthly payments. For example, the difference in cost between a £200,000 repayment and interest-only mortgage, priced at 5% over 25 years, is more than £300 a month.

But Clare Francis, editor-in-chief at MoneySupermarket, said: "Even if you can't afford the higher monthly payments on a repayment basis, try and overpay whenever possible - even if you are tied into a deal, many lenders will allow you to overpay by 10% each year penalty-free."

She adds: "Review all of your other outgoings and look for ways to free up some cash which can either be used to make an overpayment on the mortgage or invested somewhere that becomes your 'mortgage fund'. This can be money to go towards paying off your debt off at the end of the term."

Remortgage to a cheaper deal

 If you haven't addressed the issue of your mortgage for years, you may find you are sitting on an uncompetitive rate. The average Standard Variable Rate (SVR), which is the rate you will revert to at the end of a fixed or tracker deal, for example, currently sits at 4.24% according to our figures, though some lenders charge a lot more.

If you have owned your home for a while and have built up significant equity you may be able to switch lenders and get a better rate. It's unlikely you will be able to switch to another interest-only deal but, with the lower monthly repayments required on a lower rate, it could even be possible to switch to a repayment deal and keep your monthly mortgage costs the same.

For example, if you can get your hands on a 40% deposit, you can fix in your rate at just 2.49% for five years with HSBC, which you can read more about in Rachel Wait's article.

Have a look at what other deals are available on our mortgage comparison channel too. Bear in mind a new lender will assess your affordability from scratch - and there will typically be an arrangement fee to stump up too, which could be £1,000 or, with the very cheapest rates, even more.

Sell up, bank the cash and start again

Another option, while slightly more drastic, is to sell your property and either downsize so that you have a smaller mortgage, or bank the equity and rent for a while. "That way you can establish a new home while you're in control as opposed to being forced to sell in a hurry because your mortgage term is about to end," says Clare Francis.

The good news is for anyone looking to sell, is the housing market is picking up. According to property website Zoopla, confidence in the housing market is at its highest for three years, with 74% of homeowners expecting prices to rise by September.

Don't bury your head in the sand

If you are on an interest-only deal which you have concerns about, time is of the essence, so you should take action now, says Clare Francis: "Lenders will be contacting all customers whose mortgage terms end before 2020 to work with them on how their loans will be repaid - but there is also an onus on individuals to proactively address the situation."

You can start by contacting your own lender to discuss your circumstances, but it's is also worth seeking advice from an independent mortgage advisor who could brief you on your wider options. Our broker partner, London & Country, can be contacted on 0844 209 8725. You won't be charged anything for advice - whether you proceed or not.
Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.

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