Interest only mortgages allow borrowers to reduce their monthly mortgage payments by only paying interest on the outstanding loan balance.
Capital repayments are not made on a monthly basis with interest only mortgages. Instead, the payment of the capital portion of interest only mortgages is deferred until the end of the term of the mortgage.
Because interest only mortgages reduce the amount of the payments due to the lender each month, they are a popular vehicle for individuals to finance the purchase of their first home.
Interest only mortgages can help ease the financial burden involved with home ownership, allowing for borrowers to get a foot on the property ladder and switch to a repayment mortgage when it becomes more affordable.
Interest only mortgages are therefore a short-term solution to the high cost involved in borrowing money to acquire property. While interest only mortgages are popular at all times, they become even more popular during times of high interest rates.
Despite the advantage of reducing the amount of each monthly mortgage payment during the term of the loan, interest only mortgages have a large disadvantage in that they leave the borrower with a large balance to repay at the end of the term.
To ensure this does not happen, the borrower should either switch to a repayment mortgage at some point during its term of the mortgage, or set up a Capital Repayment Vehicle (CRV).
A Capital Repayment Vehicle is an investment policy designed to produce enough money to repay the balance of an interest only mortgage at the end of its term.
CRVs are usually found in the form of an endowment policy, an ISA-based investment scheme, or a personal pension plan.
Regardless of how the borrower is planning on repaying the capital portion of the loan, a level term assurance policy should be taken out when the interest only mortgage is established.
A level term assurance policy will pay out a fixed sum upon death of the assured. The amount assured should cover the capital portion of the mortgage.
Because of the risks involved, borrowers should consult an independent mortgage adviser before applying for interest only mortgages to ensure that the right product is selected to suit their personal financial situation.
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