Getting on the property ladder is harder today than it ever has been, and is one of the major financial differences between the current generation of first-time buyers, and the generations who came before them. Houses today typically cost several times more than they did thirty years ago, and salaries haven’t risen with inflation. That means that while the parents of first-time buyers may have borrowed double their annual salary to get their first house, the average first-time buyer may be left with a debt of more than four times the amount they earn in a year.
Given the size of the loans that people now have to take out to cover the ownership of their homes, it’s tempting for people to choose to repay those loans on an ‘interest only’ basis rather than a full ‘repayment’ basis. Once, they were the preserve of those who intended to pay their mortgage off with a cash lump sum in the future, or those who let their properties out and ultimately intended to sell them. Now, they’re increasingly being used as a means for those who want to own a property at any cost. An interest-only mortgage means lower monthly repayments and therefore less strain on your monthly income – but is it right for you?
Agreeing to take out an interest-only mortgage is a decision that will be arrived upon mutually between yourself and the institution which is lending you the money. For lenders, giving a first-time buyer hundreds of thousands of dollars is a gamble in any circumstances, because that person doesn’t have any track record of paying back debts of that size.
Lenders aren’t happy gamblers. If they see a reason not to lend to you, they probably won’t. While they’ll take a gamble, they prefer their odds to be 5/50 at worst, like betting on red or black on a roulette table. If they decide the gamble is more like playing on a mobile slots website like Amigo Slots, where each bet they take could have thousands of different possible outcomes, they won’t lend. Slots on mobile are a lot of fun for someone placing a small stake in the hope of winning a larger reward. They’re less fun for a bank paying out huge sums of money without knowing if they’ll ever get it back at all. They want the jackpot you get from slots, but the odds they get from 50/50 bets. They control the game, so they get to make the rules. Just because you want an interest-only mortgage doesn’t mean you’re guaranteed to get one!
Here are a few questions you should ask yourself before applying to take one out.
Do You Understand What An Interest Only Mortgage Is?
Incredibly, some people will go all the way through the process of acquiring an interest-only mortgage without completely understanding what it is they’ve done. They see that they have a mortgage term of, for example, 30 years, and they see that they have a monthly repayment. They therefore assume that after they’ve maintained those payments for thirty years, their mortgage will be paid off. That’s incorrect. None of it will be paid off. A mortgage comes with an interest rate applied to the lump sum borrowed, and with an interest-only mortgage, only the monthly value of that interest is paid. After thirty years of making payments, you will not have paid a single dime off the amount you owe against your home.
Do You Have A Repayment Vehicle?
The bank will ask you this, so it’s best to come up with a good answer before you go to them. As you’re not repaying any of the capital you owe to the bank – just the interest they’re missing out on by having the money invested in your home – the bank will want to know how you intend to repay the loan once you reach the end of your term. Are you expecting to inherit money, for example? Do you have savings or investments which are due to mature by that point? If the answer to either of those questions is yes, and your plans are realistic, you likely won’t have a problem. If your answer is just ‘I’ll sell the property,’ it’s likely you will. House prices, as we know, can go up or down. Over the thirty years you owe the money, there could be a huge economic recession, which means your house is worth less than you paid for it. In that scenario, selling it wouldn’t repay the debt.
What Happens If Something Goes Wrong?
When a customer is on a full repayment mortgage and something goes wrong in their life – typically a divorce, a bereavement, or the loss of a job which will have a short to medium term impact on their income, they might phone their mortgage lender and ask to switch to an interest-only mortgage for a short period of time while they try to get a handle on their situation. This eases the financial burden on them. Someone who’s already on an interest-only mortgage doesn’t have this option – and it’s unlikely you’ll be able to take a payment holiday unless you have an exceptionally sympathetic lender. Could you use some of the money you’re saving by taking an interest-only mortgage to buy insurance against the payments, perhaps?
Are You Comfortable Having No Equity?
This is a long term concern that most interest-only buyers never consider. Unless you put down a large deposit on your property, or your property significantly increases in value as the years pass, you will never have much, if anything, in the way of equity in your home. That matters. Most people’s greatest asset is their home. It can be used as a form of security to take on further borrowing when it might be required later in life – for example, to pay for a child to go to college, or to carry out home improvements. It can be left behind in a will. If you don’t have any equity in your home, you won’t be able to leave it to your children, or to anybody else. Should you pass away during the term of the mortgage, then unless you’ve insured yourself against the full balance owed, the full amount owed to the mortgage lender is payable by your estate. It’s not an asset; it’s a debt.
How Will You Pay In Retirement?
One of the most common reasons people take an interest-only mortgage is that they can’t comfortably afford the costs of a full repayment mortgage against their salary. Are you expecting your salary to increase dramatically over the course of your career? Are you expecting to be earning more in retirement than you are in employment? If not, then you’re going to have big problems maintaining the repayments against your home if the term takes you into retirement age. Most lenders won’t even entertain the idea of allowing this to happen – they’ll instead insist on you having a repayment vehicle in place by the end of your working life.
If you can’t think of good answers to the above questions – or they make you uncomfortable – then it’s likely the case that an interest-only mortgage isn’t for you. Don’t take our word for it though – we have no way of knowing your individual circumstances. Seek the advice of a qualified professional before making any decisions on home borrowing.
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