Interest only mortgages have been in the news quite a bit in recent times. Many people were attracted to these mortgages years ago because they were a good way of paying back less each month. As the name suggests, you pay back the interest due on the mortgage amount on a monthly basis. The capital – the amount you borrowed in the first place – must be paid back at the end of the mortgage period.

As such it maybe necessary to put money into an investment vehicle that will grow over time. The idea is that this amount will be large enough by the end of the mortgage period to pay back the capital amount. However, there are still mortgage lenders who will lend to you without a suitable repayment vehicle although these are few and far between in today’s market place.

Are interest only mortgages suitable for residential purchases?

It depends on your circumstances. There were arguably two types of householders who got into trouble with these mortgages in previous years. They were either the ones who didn’t understand the terms of the mortgage, or didn’t take the necessary steps to save and invest for the capital sum to be paid off.

There are plenty of options available for saving the required amount of money. For example you could use:

  • ISAs focusing on stocks and shares
  • Endowment policies and similar plans
  • Shares
  • Pensions
  • Property sales

This list is not exhaustive either – there are other options available too. The main thing is to ensure you can prove you have a strategy in place now that will repay the amount you wish to borrow in at the end of the mortgage term. It might sound like a long time but you need to plan for it in advance of asking for the mortgage.

Buy to let interest only mortgages

In the case of buying a property to rent, you will almost certainly be offered an interest only mortgage. This means you need to think very carefully about how you will pay back the capital amount.

The interest rates on a buy to let mortgage vary depending on the lender, the amount borrowed and whether you get a fixed rate over a specific term or not. You need to bear all these points in mind before choosing your mortgage provider.

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Of course you must also consider how you will repay the capital at the end of the term, just as you would if you were buying a residential property. You should aim to invest at least some of the rental income derived from the property into a suitable investment vehicle. This will help you pay off the amount owed on the property at the end of the term.

Be realistic about the rate of growth of investments

There are various calculators around that can help you work out how much you must put away monthly to cover interest only mortgages when they need to be paid off. However, make sure you are realistic about how much your investment might grow over 25 years. Being unrealistic at this stage could lead to a shortfall later on if you don’t put away enough each month – as evidenced by the endowment saga over previous years.