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Equity Release to Pay Off an Interest-Only Mortgage

An interest-only mortgage is a type of mortgage loan which allows you to only pay the interest on your mortgage each month, keeping your monthly payments down to a minimum.

Your mortgage will last for a set amount of time, and your interest will be fixed for a few years at a time [1].

Each month, you will only pay off the interest on your loan, rather than the initial loan amount. This will keep your rolling interest at bay.

This means that your monthly mortgage repayments are significantly less than if you were to opt for a standard, traditional mortgage.

The maximum you are usually able to borrow with an interest-only mortgage is around 4.5 times your annual income.

When your mortgage term comes to an end, you will still need to pay off the initial loan amount, in full.

This capital lump sum won’t have changed over the years, so you will know exactly how much it will be when you first take out the mortgage.

As this lump sum will be a significant amount, your lender will always ask for evidence that you will be able to pay this amount. This could be evidenced in savings, or in the form of inheritance or a pension pot [2].

Naturally, things might change over time, meaning that your intended payment vehicle may no longer be in place by the time you come to repay the capital amount.

For example, your pension pot may have reduced or your inheritance may have fallen through. In this case, many people might feel forced to sell their home or other assets in order to pay off this final amount [1].

This is where equity release comes in. Equity release allows individuals the chance to repay their final loan amount without having to sell their home or other assets. With equity release, you don’t have to make any repayments whilst you still live.

The loan only has to be repaid once you pass away or move into a care home.

You spend your equity release funds on whatever you want.

However, if you have a pre-existing interest-only mortgage then you will be expected to pay off the capital lump sum amount before spending your money on anything else.

Advantages of an interest-only mortgage

Below, we outline the advantages of an interest-only mortgage:

1. Lower monthly payments

Interest-only mortgages are unique to other types of mortgages and there are many advantages associated with taking out this type of mortgage.

For example, your monthly mortgage payments will be lower than with a standard mortgage, meaning that you will have more disposable income to enjoy on your lifestyle as opposed to paying off your mortgage [3].

2. More control over your investments

Likewise, many argue that by taking out an interest-only mortgage, you will have greater control over your investments, meaning that you get to decide how you save up enough money to repay the capital at the end of your mortgage term.

3. Defer your larger payments to later in life

For any first time buyers, opting for an interest-only mortgage means that you are able to keep your monthly mortgage payments down to a minimum, meaning that you have more money to enjoy or invest elsewhere.

Additionally, it allows individuals the chance to defer their large mortgage payments until they’re older, when they might be earning a lot more than they are now.

Disadvantages of an interest-only mortgage

Below, we outline the disadvantages of an interest-only mortgage:

1. Repaying the full capital amount at the end of your mortgage

The biggest disadvantage of an interest-only mortgage is that you have to repay the full, capital amount by the time your mortgage term comes to an end.

This will be a significant amount and in order to qualify for an interest-only mortgage in the first place, you will have to provide evidence that you will be able to pay off this amount [3].

2. Capital amount remains the same

Another disadvantage associated with interest-only mortgages is that as you only pay the interest on your loan each month, the capital you owe is not reducing, as it does with other types of traditional mortgages.

Due to this, you continue to pay interest on the full amount, which will not be reduced each year [3].

3. Higher risk

Finally, interest-only mortgages are typically higher risk than other types of mortgages.

If your repayment vehicle does not perform as expected (your pension pot reduces or dips) then you might struggle to pay off the final capital amount.

In this case, you might be forced to sell your home or other assets in order to pay off the final loan amount.

4. What happens at the end of an interest-only mortgage term?

When your interest-only mortgage ends, you will have to pay off the loan in full with one lump sum payment. This amount will be agreed on when you first take out the loan and won’t have changed, as you will pay off the interest on the loan each month [4].

Your lender will get in touch 12 months before this lump sum is owed back. They will remind you months in advance and will also notify you of the final lump sum amount.

If you are under a certain age, you might be able to extend your mortgage term or switch to another lender.

Before you qualify for an interest-only mortgage, your lender will need to see evidence that you will be in a position to pay off this final loan amount. This might be through proof of savings, expected inheritance or your pension.

Is equity release an interest-only mortgage?

Whilst equity release loans and interest-only mortgages are similar in some ways, they are different in terms of their nature, their regulation and their terms.

Some people choose to opt for an interest-only lifetime mortgage, which allows them both the benefits of an equity release loan as well as an interest-only mortgage.

What are the differences between a lifetime mortgage and an interest-only mortgage?

There are numerous key differences between lifetime mortgages and interest-only mortgages.

Before taking out either loan, it is important to understand and learn the key differences between equity release loans and interest-only mortgages. Some of these key differences are explained below [5].

1. Mortgage and loan term

The biggest difference between an equity release loan and an interest-only mortgage is the mortgage and loan term. With interest-only mortgages, your mortgage will have an end date.

On or by this end date, you will be expected to repay the loan amount. With equity release loans, your loan will not have an end date.

Your loan will continue for as long as you live, or for as long as you remain living in your home, until you move into a care home or care facility for health reasons [5].

2. Affordability

Another key difference between equity release loans and interest-only mortgages is the affordability aspect. With interest-only mortgages, you will need to prove that you can afford to pay off the monthly mortgage interest payments.

If the mortgage term is expected to go into your retirement, then you will also need to provide evidence for how you will be able to afford the payments in retirement, too [5].

Whilst interest-only mortgages are affordability assessed, equity release loans are not.

This is because there are no mandatory monthly mortgage payments with equity release loans, and the loan amount will be repaid by using the proceeds from the sale of your home after you pass away or move into a care home.

3. Maximum loan amounts

The maximum loan amount you can borrow differs with each different type of loan. When it comes to interest-only mortgages, the maximum amount you can borrow will depend on what you can afford.

This will be determined through affordability checks, assessing your income and your outgoings.

When it comes to equity release loans, the maximum amount you will be able to borrow will depend on the value of your property, your age and your health.

The older you are, then the more you will be able to borrow and release from your home [5].

4. Repayment method

Likewise, the repayment method differs between equity release loans and interest-only mortgages.

With equity release loans, your loan will be repaid through the sale of your home. Once you pass away or move into a care home, your family and next of kin will be responsible for selling your home.

The proceeds from the sale of your home will pay off the loan, in full. If the proceeds from the sale of your home no longer covers the loan amount then the lender will pay off the rest [5].

5. Monthly, mandatory payments

When it comes to interest-only mortgages, you will have to pay mandatory monthly interest payments. Whilst these payments will be lower than traditional mortgages, as they’re simply just interest payments, they are mandatory.

When it comes to equity release loans, there are no mandatory monthly payments. Whilst you can opt to pay off some of your loan each month, you will never be forced to.

6. Risk of repossession

Interest-only mortgages involve the risk of repossession. If you fail to keep up with your monthly interest payments, you run the risk of having your home repossessed.

This means that you will lose your home, and will have to move out. With equity release loans, it’s a different story [5].

When it comes to equity release, you will never be asked to move out of your home or sell your home.

You are able to remain living in your home for as long as you want, as long as you stick to the terms and conditions of your loan.

If your circumstances change and you choose to sell up and move home, you might still be able to do so, as long as your lender accepts your new property as part of your equity release loan.

Will equity release help you pay off an interest-only mortgage?

Taking out an equity release plan might help you to pay off an interest-only mortgage if you are aged over 55 years old and qualify.

It is important to note that if you do opt for an equity release loan, then you will be required to pay off your standard, traditional mortgage before spending your money on anything else.

It is also important to understand that if you wish to pay off your interest-only mortgage with an equity release loan, then you will have to release your money as one large lump sum, to pay off the mortgage amount.

Lifetime mortgages are the most flexible type of equity release you can opt for, which will allow you the chance to release money from your home without ever having to leave.

The great thing about opting for an equity release loan is that you do not have to repay the loan until after you pass away or move into a care home.

By doing so, you would be replacing your monthly interest payments from your traditional mortgage with your equity release loan.

You would no longer have to make monthly payments, as your interest-only mortgage would be paid off and your equity release loan would only need to be repaid after you pass away or move into care.

Taking out an equity release loan is a great option for anyone coming to the end of your interest-only mortgage, who might no longer be able to pay off the final mortgage loan amount. If you have no savings plan, and no inheritance left, then you may no longer be able to pay off your interest-only mortgage final amount.

Many people might worry that they have to sell their home in order to do so.

However, equity release allows you to gain access to the equity in your home and pay off your interest-only mortgage lump sum amount without ever having to sell your home.

Whilst your next of kin may no longer expect as much inheritance, you will be able to remain the sole owner of your home and won’t ever be forced to leave or vacate your property, as long as you stick to the terms and conditions of your equity release loan.

What is a retirement interest-only mortgage (RIO’s)?

A retirement interest-only mortgage works very similarly to standard interest-only mortgages. However, with a retirement interest-only mortgage, there are no set terms.

With this type of mortgage, your final lump sum is only due when you pass away or move into a care home.

When this happens, your home will be sold and the mortgage will be paid off. In the meantime, you will never be asked to vacate your property or sell up, and you are able to remain living in your home for as long as you want [6].

Retirement interest-only mortgages are aimed at those entering or enjoying their retirement years.

This type of mortgage is typically easier to qualify for compared to traditional mortgages, as the monthly repayments are lower, being interest-only.

When it comes to retirement-interest-only mortgages, your interest rate will be fixed for a specific term. At the end of this fixed term, which could be just a couple of years, your interest rate will then either increase or decrease in line with the typical interest rates of that time [6].

To check that you are able to repay your retirement interest-only mortgage, your lender will carry out a number of affordability checks.

The checks that are carried out will vary between lenders, but most will need to see that you will be able to meet the monthly repayments.

Retirement interest-only mortgages are usually available on either a 2 or 5-year fixed rate and allow you to borrow anything between £20,000 and £750,000.

You are also usually allowed to make optional repayments. You are able to repay up to 10% a year, penalty-free from the first day of your loan. These are not mandatory and are entirely optional [6].

How else can I repay my interest-only mortgage?

If equity release is not for you, then there are a number of other ways that you might be able to pay off your interest-only mortgage if your initial plan has fallen through.

There are a few different options which you should carefully consider and your financial or equity release adviser should be open and honest with you about all of your available options.

1. Switch to a repayment mortgage

If you find yourself at the end of your interest-only mortgage with no way of paying off the required lump sum amount, then you might be able to switch to a repayment mortgage.

You should speak to your lender, as they might be able to extend your mortgage term or switch your mortgage to a repayment mortgage.

Switching to a traditional, repayment mortgage will involve paying off the capital amount and the interest each month going forward.

Whilst your monthly mortgage repayments will be higher than you have been used to, it does mean that you won’t have to pay off the lump sum amount.

In order to qualify to do this, you will need to speak to your lender and see if you qualify to switch to a repayment-only mortgage.

They will also want to run affordability checks, to make sure that you can afford to make these higher monthly payments.

2. Switching part of your mortgage to repayment and leaving part on interest-only / hybrid option

If you want to, you can also opt to switch part of your mortgage to a repayment mortgage, and part of it to an interest-only mortgage.

Although this option is slightly more confusing and harder to get your head around, you will be getting the best of both worlds.

You will be reducing your total capital owed whilst lowering your monthly payments, compared to switching your full mortgage to a repayment mortgage.

Nevertheless, it is important to remember that you will be expected to pay off the full remaining amount by the time your mortgage comes to an end.

3. Searching the mortgage market for a better deal

Searching the mortgage market is always a great idea. Other lenders might be able to offer you better deals and interest rates, which is why you should consider searching the market for alternative options.

If you are coming towards the end of your interest-only mortgage and are worried about paying off the final lump sum, then you should contact a mortgage broker or financial adviser who will be able to help you shop the market and offer suggestions. They will take your personal circumstances into account and will only suggest the very best options and deals for you.

4. Selling other assets

If you get to the end of your interest-only mortgage and realise that you now have no way of paying off the final lump sum through savings or inheritance, then you might want to consider selling assets in order to do so. This might include a car or other prized possessions [7].

Whilst you might not think that your assets are worth much, by selling a few over the space of a few weeks or months, you could end up making a significant amount, which could at least go towards paying off the final lump sum [4].

5. Selling your home

Whilst selling your home might not be your first or favourite option, it is a pretty common way people pay off their lump sum final amount.

By selling your home and downsizing properties, you will profit. This means that depending on how much you sell your property for and how much your new property is, you could pay off your lump sum, final payment.

Alternatively, you might choose to move in with a family or loved one as you age, to gain additional support as you age.

By doing so, you will be cared for in your later life and will also be able to pay off your interest-only mortgage through the proceeds from the sale of your home [4,7].

Whilst selling your home might not be easy after all these years, it might be the best option for some.

If you are considering selling your home to pay off your interest-only mortgage, then speak to your financial adviser first before doing so, so that they can discuss your other options.

Can I extend my interest-only mortgage?

Yes, you might be able to extend your interest-only mortgage, although it is not guaranteed. This will largely depend on your lender and their final decision.

In order to qualify, you should get in touch with your mortgage lender as soon as possible and ask them the question.

You might be able to extend your mortgage term by turning part of your mortgage into a repayment mortgage and leaving the rest of your mortgage as an interest-only mortgage, pushing the final repayment date back by a few years.

If you are struggling to repay the final loan amount, then your lender might agree to allow you to repay the final loan amount in a number of smaller payments, instead of one large lump sum.

What if I can’t pay off the lump sum from my interest-only mortgage?

Unfortunately, for some individuals with an interest-only mortgage, they are simply unable to pay off the lump sum.

The reality is that pensions, savings or investment pots might be at an all-time low by the time your interest-only mortgage comes to an end, meaning that you are simply unable to pay off the lump sum when the time comes.

This means that instead of paying off the lump sum and finally becoming mortgage-free, your future could be at risk. If you are unable to pay off the final lump sum, then you might run the risk of losing your home.

According to the Financial Conduct Authority (FCA), approximately 77,000 people will be coming to the end of their interest-only mortgage each year, between now and 2032 [8].

This is a worrying statistic, as the effects of the 2020 Covid-19 pandemic and the cost of living crisis mean that a significant amount of these individuals might not be able to pay off their final lump sum.

As you can see, there are a number of different ways you might be able to pay off your interest-only mortgage, if your initial plan falls through. However, each and every one of these above options involves an element of risk. This is why for the majority of people, the best option is equity release.

Talk to Equity Release Warehouse

If you are considering using equity release to pay off your interest-only mortgage, then speak to a member of our team at Equity Release Warehouse. Our team are on hand to provide you with the very best information so that you can make the decision that is right for you.

If you are coming towards the end of your interest-only mortgage and are worried about how you will repay the final capital amount, then you should carefully consider your options.

Equity release is a fantastic option for many people in this situation, but there are a number of alternative options, too.

Your adviser will provide you with information regarding all of these options so that you can make a considered decision.

Speak to a member of our team at Equity Release Warehouse by calling us on 0330 058 1579 or by visiting us online www.equityreleasewarehouse.com.

References

[1] https://www.natwest.com/mortgages/mortgage-comparison/interest-only-mortgage.html

[2] https://www.halifax.co.uk/mortgages/help-and-advice/what-is-an-interest-only-mortgage.html

[3] https://www.chase.com/personal/mortgage/education/financing-a-home/what-is-interest-only-mortgage

[4] https://england.shelter.org.uk/professional_resources/news_and_updates/homeowners_rights_at_the_end_of_their_mortgage_term

[5] https://www.equityreleasewarehouse.com/plans/retirement-interst-only-mortgage/

[6] https://www.santander.co.uk/personal/mortgages/new-customers/later-life-mortgages

[7] https://england.shelter.org.uk/housing_advice/repossession/options_if_you_cannot_pay_off_your_interest_only_mortgage/term_ends_soon

[8] https://www.fca.org.uk/publication/research/fca-interest-only-mortgage-review.pdf