Our mortgage deal is coming to an end next year and we need to start thinking about the remortgage.
Given hw much rates have gone up, we are facing the prospect of paying roughly £550 more each month when we switch. That’s an extra £6,600 a year.
We are unsure we are going to be able to manage the extra cost given how much everything else is costing us, and the fact that we are just about to have our first child.
Mortgage nightmare: Many homeowners are facing the prospect of mortgage costs soaring thanks to successive rate hikes
We were wondering if moving to an interest-only mortgage could be a good way to navigate these difficult times.
Is it easy to get one, and are there any downsides we should be aware of other than the fact that we won’t actually be paying off our mortgage balance for some time?
Ed Magnus of This is Money replies: There will no doubt be many people just like you, wondering how they are going to cope with higher mortgage costs.
Bank of England officials estimate that 4 million households will be hit with more expensive mortgage bills over the next year.
The average two-year fixed mortgage is now 5.8 per cent with a five-year fix at 5.61 per cent, according to Moneyfacts. This time last year they were 2.34 per cent and 2.64 per cent respectively.
This means that a typical person with a £250,000 mortgage fixing for two years with a 25 year term will now have to pay £1,580 per month compared to £1,102 per month a year ago. That’s a 43 per cent rise in costs and a total of £5,736 more a year.
It’s worth pointing out that fixed mortgage rates have been falling since they peaked in October. The cheapest deals now charge under 4.5 per cent.
>> Find out what mortgage rates you could apply for at the moment
Ups and downs: Mortgage rates have gradually risen since the Bank of England began raising the base rate. They then spiked after the mini-Budget, but are now slowly reducing
One way to reduce monthly repayments is to switch to an interest-only mortgage.
With an interest-only mortgage, you will only pay the interest each month, with the loan amount remaining the same.
This differs from a typical repayment mortgage where you will pay back a part of the loan, as well as the interest, each month until you eventually pay off the mortgage.
With interest-only, your monthly payments will be lower – but at the end of the mortgage term, the full amount you borrowed will need to be repaid in one lump sum.
You can also go on to an interest-only mortgage temporarily before switching back to a repayment mortgage, as you are suggesting – in which case you would need to repay anything outstanding at the end of the term.
To avoid this situation, it would be possible to overpay the mortgage when you switch back to repayment in order to reduce or eliminate the final lump sum payment.
You can overpay on an interest-only mortgage, but it will only reduce future interest payments and not increase the equity you have in your property.
Most fixed, repayment mortgage deals allow borrowers to make overpayments of 10 per cent of the total mortgage amount each year without incurring penalty charges.
There are stricter barriers when applying for an interest-only mortgage. Some lenders have minimum income requirements of between £75,000 and £100,000 for interest only
This means that, in theory, you could use an interest-only mortgage temporarily and still pay off the debt in lump sum payments spanning over 10 years or more.
Someone with a £250,000 mortgage being repaid over 25 years on a two year fixed rate of 5 per cent will pay £1,462 a month. If they switched their to an entirely interest-only deal their monthly costs would fall to £1,042.
However, the challenge for borrowers seeking an interest-only mortgage for their own home is that they are subject to much stricter lending criteria.
For further advice, we spoke to Mark Harris, chief executive of mortgage broker SPF Private Clients and Chris Sykes, technical director and mortgage consultant at Private Finance.
> How much would your costs rise by? Mortgage interest rate rise calculator
How can you reduce your mortgage costs?
Chris Sykes replies: This is a dilemma faced by many at the moment. It is good to think about a remortgage nice and early in the process so any necessary decisions can be made to accommodate higher costs.
You can often apply for a remortgage six months before your product runs out and be insured against future rate changes.
There are three main things I am seeing clients do at the moment if they need to combat the higher mortgage costs.
First, some are using cash from savings or investments to pay down the mortgage.
For many, paying down their mortgage is the best solution. The less you are borrowing the lower your monthly payments are going to be.
Obviously you need to have savings to do this and you wouldn’t want to deplete a rainy day fund in order to do so.
Others are Increasing the mortgage term if this is possible to do. This helps to spread the cost of the mortgage over a longer time frame and reduce monthly costs.
This does however significantly increase the interest cost you pay over the term of the mortgage so it’s a decision that should not be taken lightly.
Finally, we are also seeing some clients put some or all of the mortgage on interest-only, like your reader is considering.
>> Finding it hard to meet your monthly mortgage payments? Here’s what to do
Who can get an interest-only mortgage?
Mark Harris replies: If you are thinking about switching to interest-only to bring down your monthly repayments, there are some key drivers which determine whether a lender will consider such an application.
Lenders will want to see evidence of how you plan to repay the capital at the end of the mortgage term.
What is loan-to-value?
Loan-to-value is a measure of how much you are borrowing on a mortgage compared to a property’s value.
It is dependent on the size of deposit you can put down or the equity in your home.
Someone putting down a £10,000 deposit on a £100,000 home would need a £90,000 mortgage.
This is 90 per cent of the property’s value, so they would be borrowing at 90 per cent loan-to-value.
Similarly a homeowner whose property is worth £100,000 and has an outstanding mortgage of £90,000 could remortgage at 90 per cent loan-to-value.
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.
This is typically around the 75 per cent-mark but there are lenders willing to go above this, particularly if the borrower wants to split the mortgage into part interest-only and part repayment.
If you plan to sell the property in order to repay the mortgage, while using what’s left to purchase another smaller property outright, the lender may want evidence that there are enough funds to do this.
You will need to prove you will have enough cash leftover from any sale to buy the next property outright.
Some lenders also tailor this requirement depending on the area you plan to downsize to.
Some lenders 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 some lenders have no minimum income requirements.
There are also age considerations, with most lenders having a maximum age for which they are willing to accept applicants.
This is typically around the 75 to 85 age range. However, should you be opting for interest-only, that maximum age may be reduced.
The mortgage size is also a consideration with some lenders having a cap on the mortgage amount they will permit on an interest-only basis.
Are interest-only mortgages a good idea?
Chris Sykes replies: Interest-only mortgages are more highly policed than your standard repayment mortgage, as it is a big financial decision to have debt that isn’t being paid down.
There are many mortgage prisoners – older people with interest-only mortgages they didn’t manage to pay back and who are stuck in debt far longer then they expected to be.
But interest-only mortgages can also be a great tool, especially if your income is variable – for example if you get large bonuses you intend to use to chip away at the interest-only balance.
But you do need to be careful as many people intend to pay them down over time but don’t manage to do so.
This means the level of interest paid over the lifetime of the mortgage can be extreme, much larger than on a repayment mortgage.
What to do if you need a mortgage
Borrowers who need to find a mortgage because their current fixed rate deal is coming to an end, or because they have agreed a house purchase, should explore their options as soon as possible.
This is Money’s best mortgage rates calculator powered by L&C can show you deals that match your mortgage and property value
What if I need to remortgage?
Borrowers should compare rates and speak to a mortgage broker and be prepared to act to secure a rate.
Anyone with a fixed rate deal ending within the next six to nine months, should look into how much it would cost them to remortgage now – and consider locking into a new deal.
Most mortgage deals allow fees to be added the loan and they are then only charged when it is taken out. By doing this, borrowers can secure a rate without paying expensive arrangement fees.
What if I am buying a home?
Those with home purchases agreed should also aim to secure rates as soon as possible, so they know exactly what their monthly payments will be.
Home buyers should beware overstretching themselves and be prepared for the possibility that house prices may fall from their current high levels, due to higher mortgage rates limiting people’s borrowing ability.
How to compare mortgage costs
The best way to compare mortgage costs and find the right deal for you is to speak to a good broker.
You can use our best mortgage rates calculator to show deals matching your home value, mortgage size, term and fixed rate needs.
Be aware that rates can change quickly, however, and so the advice is that if you need a mortgage to compare rates and then speak to a broker as soon as possible, so they can help you find the right mortgage for you.
> Check the best fixed rate mortgages you could apply for