The ticking time-bomb of interest-only mortgages

Interest-only mortgages are a disaster waiting to happen, industry experts have warned.

As property prices have risen further and further beyond the reach of many homeowners, ever-more Britons are choosing to take out huge loans on properties and only repay the interest on them.

This trend has been reinforced by the seemingly unstoppable rise in house prices, where homeowners feel their house price will accelerate far beyond the cost of their mortgage, seeing them safe should things take a turn for the worst.

But today, leading mortgage experts have warned that this trend could lead to huge problems later on.

"While the use of interest only mortgages is not something new, and has historically been used successfully, the change has been surrounding the repayment vehicle," said Julia Harris, mortgage analyst at Moneyfacts.co.uk.

"The early 90s saw regulatory change and consequentially the rules were relaxed on lenders having to hold a legal charge over an investment vehicle."

Before this, lenders ensured people taking out interest-only mortgages were putting enough money away to repay the loan.

In 1992 four first-time buyers in five used an interest-only mortgage alongside a repayment vehicle, compared with one in 20 in 2005, Moneyfacts points out.

"Many consumers may choose interest only initially, with the intention to move to capital repayments in the near future, when their financial situation improves," Ms Harris said.

"But should they wish to keep the same repayment term, they need to be aware of just how much the costs will rise in the future."

Monthly payments on a 25-year, £150,000 mortgage would shoot up from £625 to £1,186 if the mortgage-holder waits ten years before deciding to start repaying the cost of the original loan rather than just the interest, Moneyfacts points out. If people had been making capital repayments from the start monthly costs would be £876.89.

Taking the second option will cost homeowners a staggering £25,000 more in interest payments over the term of their mortgage.

"Consumers can soon become comfortable with the lower monthly repayments, but unless careful future planning and budgeting is used, they may find they can’t afford to pay off the loan by the end of the term, leading possibly to mortgage defaults and ultimately in the worst-case scenario, repossession," Ms Harris warned.

"The jump from interest-only to capital repayment can be a huge. Borrowers can soften the blow by using the option of partial repayments which many lenders now offer, allowing the borrower gradually to build up the percentage of the capital that is paid at a rate comfortable to their circumstances."

But interest only mortgages are still better than renting, she noted.

"By repaying interest-only, you are not subject to landlord terms, are able to make improvements to the property and as long as you are fully aware that you may need to convert back to rented accommodation if the repayments become unaffordable come retirement if your income levels drop.

"There is also scope for capital appreciation, an opportunity you would not see should you rent, but on the downside if there was a sharp downturn in property prices, you could be faced with a situation of having to pay for rent and some negative equity."