Can I get an interest-only mortgage? My funds are set to soar £400 per thirty days: DAVID HOLLINGWORTH replies

Our five-year fixed mortgage deal is coming to an end in May next year and we need to start thinking about remortgaging.

Given that interest rates are now higher, we will be paying roughly £400 more each month from May if we lock in a deal now. That’s an extra £4,800 a year.

My wife and I are worried about the extra cost given that since we took out the last mortgage we have had two children, which is also proving to be rather expensive.

We were wondering if moving to an interest-only mortgage for a period of time could be a good way to reduce our overall costs. We would resume paying the mortgage balance when our finances improved. 

Our outstanding mortgage is currently just over £300,000 and we think we have between 30-40 per cent equity in the property.

My first question is, how easy it is to get an interest only mortgage? Will we be paying a higher rate for doing so? And are there any downsides we should be aware of other than the fact that we won’t actually be paying off any of our mortgage balance? 

What will we need to tell lenders in order for them to agree to giving us an interest-only mortgage?

Mortgage help: Our weekly Navigate the Mortgage Maze column sees broker David Hollingworth answering your questions

David Hollingworth replies: You will no doubt have enjoyed considerable benefit from locking into a low rate five years ago, which will have given you protection from the volatile rates of the last few years. 

Mortgage rates are now substantially higher than they were when you took your current deal, even though they have reduced from their recent peak.

You have some time to consider the range of options open to you and how you can best mitigate any increase, but it makes sense to start three to four months before the end of the current deal. 

Some have used the low fixed-rate period to overpay and try to reduce the balance more quickly but that is easier said than done, especially with two new additions to the family.

That will have affected your disposable income and so will also feed into your mortgage lender’s affordability calculations. Higher costs such as childcare, which can be particularly significant, can put a squeeze on the amount they will be prepared to offer.

An interest-only mortgage will reduce the monthly payment which could help your month-to-month expenditure. However, the key difference is that you will not be reducing the mortgage balance.

That could be something that would help you, as a short-term measure. The Mortgage Charter made a temporary switch to interest only possible to help borrowers struggling with the cost-of-living crisis.

The Charter is a package of Government measures, introduced in July 2023 as mortgage rates soared. 

Lenders do offer interest-only mortgages, and although that can sometimes carry a slightly higher interest rate, many will enable interest-only lending on the same rates as repayment mortgages.

> What next for mortgage rates in 2024 – and how long should you fix for? 

Who can get an interest-only mortgage?  

Interest-only mortgages will often carry a number of tougher eligibility and criteria requirements. 

For example, a number of the bigger lenders will expect the borrowers to have a minimum level of income in order to qualify.

Often, that could require a minimum income of £75,000 for one applicant, or a total of £100,000 or more for joint applicants.

Most lenders will have a maximum percentage of the property value, referred to as loan to value (LTV), that they will offer for interest-only applications.

You have a good level of equity which should make interest only a possibility. However, the lender will also want to know how you propose to repay the mortgage when the term ends. 

Of course, you might choose to switch back to a repayment mortgage when your finances allow – but the lender will still need to see that you have a plan to repay the loan if you did not.  

That could be an investment vehicle that you contribute to alongside the mortgage, which the lender will want to corroborate, or could potentially be the sale of the property itself.

However, the latter can often see the lender impose a tighter LTV and come with an expectation of a minimum level of equity in the property. 

That varies by lender and can also depend on where your property is but can often sit in the region of a £200,000 to £300,000 equity buffer.

Is an interest-only mortgage your best option?  

Even if you can meet the tougher criteria, I think you should still think very carefully before making a switch to interest-only. 

The longer that you go on without putting a dent in the mortgage, the harder it gets to switch to repayment. 

In the past this has ended with borrowers ultimately having to extend the life of the mortgage or even facing the prospect of having to sell the property to repay the balance.

Although it will reduce the monthly payments, it’s not a cheap mortgage and you will pay much more in interest over that period. 

For example, taking a £300,000 mortgage, on a 25-year term, with an interest rate of 4.50 per cent would cost you £1667.50 per month. 

On an interest-only basis, that would reduce to £1,125 per month – but you would incur £137,250 more in interest over the life of the loan, as well as leaving the balance.

Alternative options could include taking only part of the mortgage on interest only, with the remainder on repayment so you continue to reduce the bulk of the mortgage each month. 

You could also think about another measure that the Mortgage Charter adopted, and keep the mortgage on a repayment basis but consider lengthening the term of the mortgage.

That will still cost you more in interest, but will help to mitigate the increase in the mortgage payment. 

You can also then consider making overpayments in the future, or shortening the term back down, to bring down the total interest bill for the mortgage.