What is an interest only mortgage?
An interest only mortgage (IOM), as the name suggests, enables homeowners to only repay the interest they owe each month, rather than interest and capital payments.
Interest only mortgages are a great way to borrow for those looking to keep the size of their monthly repayments to a minimum. As you only repay the interest each month, with the capital due at the end of the term, the repayments are smaller than their capital repayments counterparts.
The advantage of an interest only mortgage is that the customer only needs to prove they can afford the monthly interest repayments, meaning they can be more affordable and easier to qualify for.
How can equity release help pay an interest only mortgage
For those without a plan in place, equity release can provide a financial lifeline. According to equity release advice company Responsible Equity Release, around one in four equity release customers use some of their release to pay off an existing mortgage. With a lifetime mortgage, the most common type of equity release, the amount you release, plus the interest owed, only has to be repaid when you die or move into long-term residential care.
Retirement interest only mortgage (RIOM)
Another option is a retirement interest only mortgage (RIOM), but this type of product is only suitable for homeowners with a dependable income throughout retirement. An equity release lifetime mortgage doesn’t require homeowners to make monthly repayments, whereas a RIOM requires you to carry on paying interest. The lender receives the capital when the property is sold, again either when the homeowner dies or moves into long-term care.
Steve Wilkie, managing director of equity release specialist Responsible Equity Release, said:
“With a lifetime mortgage, you do not have any compulsory payments. As there’s no payments to miss, you can’t face repossession. A RIOM, like most mortgages, carries compulsory repayments and the risk of repossession if they are missed. With compulsory payments, you have affordability checks.”
Why consider equity release?
Older homeowners unlocked a record £136 of property wealth every second in Q4 2018, with many using their newly released capital to pay off interest only mortgages.
The Financial Conduct Authority estimates that over 40,000 interest only mortgages are due to mature every year between 2017 and 2032. Unfortunately, thousands of borrowers who took out these mortgages prior to the credit crisis do not have an adequate repayment strategy in place to repay the capital they borrowed.
Equity release does not require proof of any income or affordability.
With a lifetime mortgage, the customer receives cash in exchange for a first-charge on their property to the equivalent amount. This cash release can then be used to repay any existing mortgage, all in the same legal transaction.
Equity release is evolving
Equity release schemes have become much more flexible in recent years, giving customers the option to pay interest each month, rather than it rolling up, or to make voluntary capital payments free from early repayment charges.
According to latest figures from the Equity Release Council, as of August 2018, 139 product options were available to consumers – more than double the number in 2016, and up from 24 in 2007.
Chairman of the Equity Release Council, David Burrows, said:
“With a growing choice of products and features on offer, the market is maturing and adapting to offer a new level of flexibility to suit a range of financial needs and ambitions.”
Professional equity release advice is essential
Always seek professional advice if you are considering this type of scheme, as equity release will reduce the value of your estate and could affect your entitlement to means-tested state benefits. It’s also worth noting that equity release interest rates tend to be higher than standard mortgage rates, and have risen slightly in recent months.
Rachel Springall, finance expert at Moneyfacts.co.uk, said:
“Despite the recent rate increases, there are still plenty of reasons to consider equity release. That said, it's always a good idea to seek independent advice from someone who's specialised in equity release, as well as mortgages in general. A good adviser would likely insist you talk to anyone that may be affected by a decreased inheritance, so you're all on the same page before you sign up.”
Use our instant equity release calculator to find out how much tax-free cash you could unlock.
The above article was created for Telegraph Financial Solutions, a member of Telegraph Media Group Limited. For more information on Telegraph Financial Solutions, click here