Death of the interest-only mortgage? They will make up simply 2% of dwelling loans by 2034

Interest-only mortgages are plummeting in popularity, according to new research by longer-term lender April Mortgages.

It says the number of outstanding interest-only home loans has fallen by 70 per cent over the past decade to 664,000, making up just 8 per cent of all home loans.

Interest-only mortgages mean borrowers only pay the interest each month, with the loan amount remaining the same. 

They must then find a way to repay the mortgage in full at the end of the term – usually through savings or investments, an inheritance, or by selling the home. 

Assuming the decline was to continue at the same rate it would leave only 184,000 outstanding interest-only home loans by 2034, just 2 per cent of the mortgage market. 

Over the past 10 years, more than 1.5 million interest-only loans have reached maturity, according to the research, with borrowers either repaying their mortgage in full or switching to a repayment deal. 

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This means numbers have decreased by 11 per cent a year on average resulting in the interest-only market shrinking to just over one quarter of its size 10 years ago.

Interest only mortgages were once far more popular than they are today, but stricter regulations after the financial crisis meant banks were able to hand out far fewer of them, and enforced stricter criteria on applicants. 

Rachael Hunnisett, director, April Mortgages, said: ‘Part of this reduction in the market will be driven by enhanced regulatory oversight which has played a crucial role in ensuring responsible lending practices, alongside lenders scaling back or withdrawing interest-only products to align with their own appetites to lend.

‘Our projections based on market trends from the last decade reveal that interest-only mortgages could make up as little as 2 per cent of all outstanding residential mortgages by 2034. 

‘This puts the future of interest-only mortgages in doubt, and risks limiting consumer choice at a time when borrowers have proven their ability to meet repayment commitments.’

Can interest only-mortgages be helpful?

Post-2008, some people see interest-only mortgages as synonymous with irresponsible lending and reckless borrowing.

However, while it won’t be suitable for everyone, if used responsibly an interest only-mortgage can be a temporary lifeline, or even a profitable financial tool.

The majority of buy-to-let investors use interest-only mortgages to safeguard their cashflow each month, giving them quick access to funds which they can reinvest in their portfolio. 

It may also be one reason why we didn’t see a large uptick in mortgage repossessions among landlords when interest rates surged upwards in 2022 and 2023. 

For homeowners that are worried about their monthly payments shooting up, for example those that fixed at a low rate pre-2022 and are now remortgaging, an interest-only deal can provide some breathing space.

However, if they don’t have a plan to eventually repay the loan, this should only be used as a temporary measure and they should switch back to a repayment mortgage as soon as they are able. 

Interest-only mortgages also be a useful tool for someone who relies heavily on uneven income streams, such as being paid on commission or via bonuses.

A £200,000 mortgage being repaid over 20 years on a repayment mortgage at a rate of 4.5 per cent will cost £1,265 a month. A £200,000 interest-only mortgage on the same basis would cost £749 per month. 

Of course, the fact that someone is not paying down the debt, will be a concern for many.

But most mortgages allow borrowers to make fee-free overpayments each year without incurring early repayment charges. 

This means a sensible borrower can still reduce the debt over time with one-off payments.

Overpayments are typically restricted to 10 per cent of the mortgage amount each year, but can sometimes be more. 

‘The interest rate shock that many borrowers are currently experiencing as their fixed mortgage comes to an end, highlights why interest-only deals should remain widely-available to borrowers,’ added Hunnisett.

‘Homeowners who are facing a sharp rise in their mortgage repayments may not want to lock in a higher rate or have to extend their mortgage term to keep costs down.

‘An interest-only mortgage can be a viable solution in this situation as it hands control back to the borrower and provides greater payment certainty and security.

‘While interest-only mortgages are not for everyone, they can be advantageous for older homeowners with considerable equity, as well as first-time borrowers wanting to improve their affordability.’

Who can get an interest-only mortgage? 

The challenge for borrowers seeking an interest-only mortgage for their own home is that they are subject to much stricter lending criteria. 

Mortgage lenders will want to know how they plan to pay back the mortgage from the outset. This may include the sale of the home, the sale of a second property, a pension lump sum, investments or savings. 

The loan-to-value ratio of the mortgage will also influence the lender’s decision. There is usually a maximum loan-to-value above which a lender won’t agree to interest-only.

Borrowers typically need to put down a 25 per cent deposit, though there are lenders willing to go above this.

Some lenders also require you to have a minimum income, which may be £20,000 or could be as much as £50,000, £75,000 or even £100,000. But other lenders have no minimum income requirements.

In this week’s Navigate the Mortgage Maze column, broker David Hollingworth shared his advice with a reader wondering whether to switch to an interest only mortgage.

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

‘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.’

There are also alternative options that borrowers should think about, according to Hollingworth. 

He added: ‘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 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.’