Boom time for interest-only mortgages?

The ongoing effects of the credit crunch on global financial markets could encourage a growing number of homebuyers to take out an interest only mortgage.

Online mortgage firm mform.co.uk argues the difference in the repayments between an interest only mortgages - which merely pays off the interest on a loan - and those on a standard deal may prove to be irresistible to stretched borrowers.

According to the company the difference in monthly payments on an interest-only basis and a capital and interest basis can be as much as £225.25 or £2,703 a year on a £150,000 loan.

Figures from the Council of Mortgage Lenders (CML) find some 24 per cent of borrowers opt for an interest only mortgage when selecting a deal – however, this number could be set to boom.

Financial Services Authority (FSA) figures show 1.4 million cheap fixed-rate deals are set to end this year, with borrowers facing an increase of 40 per cent in the cost of their mortgage.

It is this group mform has identified as the group now likely to be plumping for interest only mortgages.

"Moving to interest-only repayments on your mortgage will help reduce your monthly costs," said mform marketing director, Francis Ghiloni.

"And it will be tempting for the 1.4 million borrowers whose fixed-rate deals are coming to an end this year."

Borrowers on these existing deals are now paying rates as low 4.23 per cent - and with the current average fixed rate of six per cent borrowers could face serious payment shocks.

Yet, interest only deals may not be the most suitable for some borrowers.

"However, tempting switching from repayment to interest-only may be, unless borrowers have plans in place to eventually repay their loan they may be simply storing up problems for the future.

"Getting to the end of the mortgage term and still owing the initial debt would be disastrous," explained Mr Ghiloni.

However, the trend toward interest-only mortgages appears to be in motion already.

Analysis by mform shows 21 per cent of loans advanced in 2006 were on an interest-only basis with borrowers not specifying a repayment method compared to 24 per cent in 2007.

In January 2008 around 24.5 per cent were on an interest-only basis.

"We would urge anyone contemplating a switch to interest-only to be careful and to research the market to find the best possible deals before taking such as step," concluded Mr Ghiloni.