The working of a traditional mortgage involved a borrower paying fully amortised payments to the mortgage lender. This means that a borrower pays an equal amount every month. This is an amount determined on the basis of a calculation done. This calculation derives the amount to be paid every month by the borrower to pay-off the loan in full.
There is usually a specific term within which the loan has to be paid off. However, there are now interest only lifetime mortgages that can suit, depending upon one’s financial demands.
Interest only mortgage loans differ from the traditional loan system because they do not require a monthly amortised payment on behalf of the borrower. Therefore, only the interest charged is paid, no capital, thus resulting in the balance remaining the same.
The workings of an interest only mortgage are explained below:-
As usual, the period of the loan is predetermined. However, the borrower now has to make a monthly payment only on the income that this loan accrues. There is no need to make a payment towards the principle borrowed whilst paying off the interest. This considerably brings down the amount to be paid by the borrower every month. If the mortgage is pre-retirement the lender will require some form of repayment, be it an ISA, low cost endowment and in some cases sale of property as a repayment vehicle.
Conversion to traditional mortgage
Given the financial issues of interest only mortgages and low cost endowment policies in the past, the most common form of mortgage is now a capital and repayment mortgage. With endowment shortfalls and even litigation on these insurance policies historically, mortgages have switched from an interest only basis over to capital and repayment. The capital and repayment route for mortgage repayment will always guarantee the eventual settlement of the loan. This is therefore best suited to the more cautious investors.
It is possible to convert to a traditional mortgage by paying off the interest only mortgage with a new loan that covers the principle amount. This will then turn the payments into the amortised payment system where interest and principle is paid each month. This works for those who have yet to enter into retirement since there is still an income to protect them.
The benefits and disadvantages of an interest-only mortgage
An interest only mortgage is beneficial to those people who cannot afford to make a fully amortised payment after having taken the mortgage. It is a comfortable way of renting your home from the mortgage company and paying only the interest till such time that you start earning greater income. However, making interest-only payments does not earn equity for the home. Also, once the loan is converted to a traditional mortgage, the payments to be made by the borrower may become considerably higher than the amount that they would have had to pay through the traditional method of payment. The longer this period is left the higher the payments are going to be.
The FCA has recently clamped down on mortgage lenders offering interest only mortgages, especially to first time buyers. But, interest only mortgages can still have a part to play when times of financial strife are upon us. Evidence of this is seen on such events as divorce or loss of employment. This should only be a temporary measure and reversion back to a repayment basis should follow as soon as possible once financial redress has been sanctioned.
Now there is a retirement option in interest-only lifetime mortgages to discuss too.
Retirement Interest-Only Lifetime Mortgages
This type of mortgage requires interest only payments; however, there may be a “lifetime” guarantee on the mortgage in which the person does not have to pay the mortgage back until they move house or die. The interest continues to accrue; however, the initial balance does not increase.
These equity release retirement products differ from the standard interest-only mortgage. Some may not differ where there is a requirement to pay the loan back in 10 years, but there are some that have no limit since life expectancy is within an affordable period for the retirement person.
If there is an issue of repayment before death, such as reaching the age of 75, then the person can consider home reversion with a lifetime tenancy agreement. A portion of the house is sold to end any payments made for the rest of their life. It means there is no amortised payment necessary on the house because it is owned without a mortgage.
For further information on all the above, we recommend visiting EquityRelease2Go.com.
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