If your interest-only mortgage is coming to an end, you’re probably wondering about the next steps.
The lender will be expecting their money back, so this is not a situation to be ignored.
Whether you are considering paying a lump sum, selling your property, or remortgaging, it’s essential to explore all options to find what works best for your circumstances.
Read on as we explain how interest-only mortgages work, what happens when they end, and the options that might be available to you.
Understanding Your Interest-Only Mortgage
Interest-only mortgages work differently to repayment mortgages, mainly in terms of payment structure and long-term financial planning.
Fundamentally, with an interest-only mortgage you need to have a plausible strategy of how to pay back what you borrowed.
With an interest-only mortgage, your monthly payments cover only the interest on the loan, not the capital. For instance, if you have a £250,000 loan at 3% interest over 25 years, you would pay approximately £625 per month. However, at the end of the term, you would still owe the full £250,000.
In contrast, a repayment mortgage for the same amount and term would require monthly payments of about £1,186, but the debt would be fully cleared by the end of the term.
As you can see, these mortgages are a much cheaper option, making the monthly budgeting a lot more affordable.
This affordability allowed many to purchase homes they might not have otherwise been able to afford.
Preparing for the End of Your Mortgage Term
It’s essential to start planning well before your mortgage term ends.
Ideally, you should begin reviewing your options at least five years in advance, with more intensive planning in the two to three years leading up to the end of the term.
This early preparation gives you more flexibility, time to implement your chosen strategy and time to make any adjustments.
What Happens When The Term Ends?
The lender will be expecting you to send them a big fat cheque to pay off your mortgage debt!
When your interest-only mortgage term ends, you have several options to consider.
The most straightforward, if you have the means, is to pay off the balance in full. This could involve using savings, cashing in investments, or selling other assets.
However, for many homeowners, this isn’t feasible, and alternative strategies are necessary.
Remortgaging to a Repayment Mortgage
This involves switching to a new lender, with a new term, that includes both interest and principal payments. It’s a reliable way to steadily pay off your debt and own your home outright eventually.
However, it requires meeting lenders’ affordability criteria, which can be stricter for older borrowers or those with changing financial circumstances.
Read more: How to change an interest only mortgage to repayment
Extending Your Mortgage
Your current lender may offer to extend your interest-only term or allow you to switch to a part-and-part mortgage, where you make partial capital payments alongside interest.
This can provide more time to save or explore other options, but it could come with higher interest rates. You will need to provide proof of your income and pass the affordability checks. Always consider the long-term implications of extending your debt.
They are not obliged to give you an extension though. So you need to be prepared for this situation. Again, giving yourself plenty of time will allow you to seek alternatives.
Using Your Assets
Repayment vehicles are financial plans or investments specifically aimed at paying off your mortgage balance at term end. These can include stocks, shares, ISAs, pensions, or endowment policies.
Investments should have been set up at the start of your mortgage or during its term. You should review these plans periodically to ensure they are on track to meet your repayment goal.
If you have significant savings or another property, these can be used to repay the outstanding balance.
Downsizing
Selling your current home and moving to a smaller, more affordable property is another way to settle your mortgage. Downsizing frees up capital, which can be used to repay the interest-only mortgage.
This option can be effective if you have significant equity in your home but don’t underestimate the emotional and practical implications.
Equity Release
For homeowners aged 55 and over, equity release offers a way to access the value tied up in your home but without having to move.
This can be done through a lifetime mortgage, where you borrow against your home’s value and make no repayments until you sell the property or pass away. This option works by converting your mortgage debt into an equity release debt, which requires no monthly payments and does not have a fixed term.
Additionally, you may choose to downsize and take out a lifetime mortgage.
Assessing Your Options
When considering your options, it’s important to take a holistic view of your financial situation.
Consider your age and retirement plans – how many working years do you have left, and how might your income change in retirement?
Think about your current and projected future income, as this will impact your ability to make mortgage payments.
The value of your property and the amount of equity you have will play an important role in your decision. If your property has increased significantly in value, you will have more options available.
Some options, like equity release, may provide an immediate solution but could impact your long-term financial security or the inheritance you leave behind. Others, like remortgaging, might require you to commit to higher monthly payments for an extended period.
If you don’t have enough funds to fully repay the debt, then a trade off is needed to cover the shortfall.
Don’t leave everything to the end
If you know, or think, that you won’t be able to fully repay your mortgage when it’s due, then don’t ignore this fact.
The earlier you acknowledge that something needs to be done, the more time you will have to implement changes.
For example, moving to an offset mortgage might work. You link your cash savings to your mortgage, only being charged interest on the difference. While you won’t be receiving any bank interest, the money you save from the offset option is tax-free! This saving could then fund an annual overpayment.
Alternatively you could choose to make small extra payments each month, over and above what you are obliged to pay. 100% of this extra money will be used to pay off the debt.
Or you ask your lender to put some of your mortgage onto a repayment basis, you would then have a part and part mortgage, with a proportion of the debt being paid off each month.
Borrowing into Retirement
Traditionally, most people hoped to be mortgage-free by retirement age.
However, the landscape is shifting.
More and more UK homeowners are finding themselves with an outstanding mortgage balance as they enter their golden years. This trend is partly due to factors like rising house prices, longer life expectancy, and the higher cost of living.
Borrowing into retirement is no longer a taboo subject.
Many lenders are adapting their policies to accommodate borrowers beyond age 65, recognising that retirement doesn’t always mean a drastic drop in income.
But there are essential considerations to keep in mind:
Affordability
The most significant factor for lenders when considering mortgage applications from older borrowers is affordability.
They need to be confident that you can manage your mortgage payments alongside your other expenses in retirement. This means taking into account your projected retirement income from pensions, investments, and any other sources.
Lenders will require proof of your retirement income, such as pension statements or investment portfolio summaries. If you plan to continue working part-time in retirement, you may also need to provide evidence of your expected earnings.
Most lenders have maximum age limits for mortgage applications, typically ranging from 70 to 85. This means your mortgage term might need to end before you reach a certain age.
Planning Ahead
The earlier you start planning for your retirement finances, the better equipped you’ll be to manage any outstanding mortgage debt.
If you’re considering borrowing into retirement, it’s helpful to speak to a mortgage adviser who can assess your individual circumstances and guide you through the available options. They can help you create a tailored plan that ensures your mortgage doesn’t become an unmanageable burden in your later years.
The end of your interest-only mortgage term marks an important financial milestone.
While it may seem daunting, taking proactive steps now can ensure a smooth and successful outcome.
We can offer expert guidance tailored to your unique circumstances, helping you explore all available options.