The Motley Fool has a good look at the problems with interest-only mortgages in The Deadliest Home Loan!
Having already admitted to taking out an interest-only mortgage for our new house (which is currently in the hands of solicitors – that’s a whole story by itself), I can agree with some of the reasons given in the article for why people (and first-time buyers in particular) choose these sorts of mortgage:
So, why are more and more homebuyers and movers arranging interest-only loans? The simple answer is that the monthly repayments are much lower, because you don’t pay off your debt until the end of the mortgage term. Furthermore, with house prices at record highs, getting an interest-only mortgage is the only way that many aspiring homeowners can stretch themselves to reach up to the first rung of the property ladder.
The article also explains how those with interest-only mortgages get hit harder when interest rates rise:
…a £100,000 interest-only loan with an annual interest rate of 5% costs £416.67 a month, compared to £584.59 for a 25-year repayment mortgage… If the interest rate on the above mortgage were to rise from, say, 5% to 6% a year, an interest-only borrower would have to cough up an extra £1,000 a year. However, a borrower with a 25-year repayment mortgage would see his/her annual repayment increase by £717, or £283 less.
So, if like me you’re stuck with an interest-only mortgage, what should you be doing? Well, unlike more than 200,000 home buyers last year, who took out an interest-only mortgage without any method for repaying the capital on their home, you need to find some way of paying off the value of the house at the end of the mortgage term.
My chosen method is to build up savings using stocks and shares ISAs. Although in all honesty, we will be looking to convert to a repayment mortgage as soon as we can afford to.
The problem is that, according to CML data, over 200,000 homebuyers arranged an interest-only loan last year without any repayment vehicle in place, including almost 61,000 first-time buyers. What’s more, in the first three months of 2002, only one in eleven new mortgages (9%) was interest only.