Buy-to-let
With an interest-only mortgage you simply repay the interest over the term of the mortgage which means monthly repayments are lower than if you opt for a repayment mortgage.
The mortgage has to be repaid at the end of the term and traditionally borrowers have used an endowment policy to repay the mortgage. But it can also be repaid by the sale of the property, or inheritance or other investments.
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Julia Harris, mortgage analyst at moneyfacts.co.uk explains: Previously the regulatory requirements stipulated that if borrowers were to have an interest-only mortgage, the lender would take a charge over the investment vehicle and ensure that over time the borrower was making sufficient payments to repay the capital amount.
In 1992, 79 per cent of first-time buyers were using an interest-only mortgage with an accompanying repayment vehicle, compared with just 5 per cent in 2005.
Borrowers can opt to keep payment low in the first few years by opting for interest only and then switching to a repayment mortgage in the future. But the leap from interest only to repayment can be huge.
Consumers can soon become comfortable with the lower monthly repayments, but unless careful future planning and budgeting is used, they may find they cant 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, says Harris.
She suggests that borrowers consider taking out a mortgage with a low fixed rate, but an extended tie in penalty as an alternative way to keep costs low in the early years.
But although these rates may appear attractive, the exit fees, set-up fees and higher rate during the tie-in period could soon take a shine off those very attractive low monthly payments experienced during the first couple of years, warns Harris.
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