Is an interest only mortgage a good idea?

For many consumers and lenders the idea of an interest only mortgage is a worrying one, as these mortgages are often seen as higher risk mortgages, and are frowned upon by some lenders who refuse to offer them in the current, riskier financial climate. However, for some people there may be no other option apart from an interest only mortgage, and this is because the repayments on a capital and interest mortgage – also known as a repayment mortgage – are simply too high to afford.

All mortgages come under one of two umbrellas, and this is the repayment mortgage or the interest only mortgage. A repayment mortgage is a mortgage whereby your monthly repayments are split between the interest that you owe on the loan and the actual principal loan itself. This means that over time you see your debt going down, and by the end of the mortgage term your debt should be clear and the property then belongs to you lock, stock, and barrel.

With an interest only mortgage your monthly repayment is only allocated to the interest that you owe on the loan, and this means that your actual principal loan balance will remained untouched over the term of the mortgage. By the end of the mortgage term you will have paid off all of the interest on your loan but will not have paid any of the actual loan itself. This is where the risk comes in. It is important to take out some sort of sideline investment when you take an interest only mortgage, and you then have to hope that the investment reaps adequate financial rewards to enable you to pay off your mortgage loan in one lump sum at the end of the mortgage term.

So, with these risks involved, why do people go for an interest only mortgage rather than a repayment one? Well, the answer is simple – it is all down to affordability. The monthly repayments on an interest only mortgage are far lower than with a repayment mortgage, and this is because you are only repaying the interest on the loan rather than the loan itself. Many people – especially first time buyers – simply cannot afford the repayments on a capital and interest mortgage, and therefore in order to get onto the property ladder they have to opt for the interest only mortgage.

If you are considering an interest only mortgage you need to make sure that you are fully aware of the risks, and that you are prepared for them. Think carefully about the different sideline investment options open to you, and discuss the whole matter with an independent financial adviser if you are unsure, as this is a very important and daunting financial decision that you will have to make. Also, do bear in mind that your choice of lenders will be far more limited, particularly in the current financial climate, when many are too cautious to offer higher risk mortgage loans.