Written by Karen Bryan
I read that Nationwide will not be offering any new interest only mortgages. No doubt it’s appealing to have lower monthly mortgage payments offered by an interest only mortgage. Whereas with a repayment mortgage, you have higher monthly payments due to the fact that are paying interest on the loan plus repaying part of the loan.
It’s a similar issue to taking out an endowment mortgage, when you can’t be sure that the maturity value of the endowment will be enough to pay off your loan in full. But at least with an endowment mortgage you are making some payments towards paying off the loan.
Being risk averse, we always took out repayment mortgages, even when other types of mortgages were all the rage. In 1988, only 12% of first-time buyer mortgages were repayment mortgages, by 2011 this figure had leapt to 96%.
I’d have only considered taking out an interest only mortgage in certain circumstances:
- If I already had a lump sum to pay back the original amount I’d borrowed and I could get a higher rate of return (after tax) from putting that lump sum somewhere else. For example, if I took out a fixed rate interest only mortgage at 3% and could earn 4% on my capital in a fixed rate savings account.
- If house prices were rising.
- If there were no early repayment penalties on the mortgage, so that if something in the favourable equation changed, I could immediately pay off the loan.
It seems to me that in the past many home buyers and their lenders just didn’t think through how these borrowers were going to repay their loan. The buyers were eager to get on the housing ladder with ever increasing house prices and the lenders were happy to get paid the interest, with the property as collateral.
But what happens if house prices tumble (as they have in most UK regions) and the property is worth less than the initial loan? The homeowner can’t repay the loan, even if they sell the property.
No wonder lenders are withdrawing from the interest only mortgage market. That still leaves the problem of existing interest only mortgagees.