Are interest-only mortgages making a comeback?

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A number of mortgage lenders are easing restrictions on interest-only mortgages.

Both Barclays and Leeds Building Society have altered their interest-only lending criteria, while other lenders are rumoured to be making plans to follow suit.

What is an interest-only mortgage?

An interest-only mortgage is an alternative to a traditional repayment mortgage. Monthly repayments only cover the interest on the home loan, not the capital.

Interest-only mortgages appeal to borrowers because they are much cheaper than a repayment mortgage. For example, if you had a £200,000 mortgage over 25 years at 2% you'd pay £847.70 a month on a repayment mortgage. In comparison an interest-only deal would cost £333.33 a month.

However, interest-only mortgages leave borrowers with a big problem: at the end of the term they will still owe the capital borrowed at the beginning.

What's the problem with interest-only mortgages?

Prior to the credit crunch lots of people opted for interest-only mortgages, as it meant they could afford to borrow more and buy a more expensive house. According to the Council of Mortgage Lenders, around a third of mortgages taken out in 2007 were interest-only.

The trouble was many of these borrowers didn't have a plan in place repay the capital – and this worried both mortgage lenders and the Financial Conduct Authority (FCA).

Since 2008 most lenders have withdrawn from interest-only lending over fears these loans had contributed to the credit bubble and left borrowers dangerously over exposed.

The FCA estimates that around 600,000 interest-only mortgages are set to reach the end of their term by 2020, and that half of those borrowers have no means to pay back the debt.

'Part and part' deals

Before 2007 you could easily arrange for your whole mortgage to be paid on an interest-only basis. Now lenders are a bit more cautious and rather than offering loans on an entirely interest-only basis, some are starting to offer mortgages on a part-repayment, part interest-only basis.

Splitting a mortgage this way can be a good halfway house for borrowers who want to switch to a repayment mortgage, but can't afford to switch the entire home loan.

Lenders are in favour of this kind of deal because it means some of the capital is getting paid off which reduces their risk exposure.

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Lenders' changing attitudes

The biggest lender to change its lending criteria for interest-only mortgages is Barclays and its mortgage arm Woolwich.

Barclays has changed its 'part-and-part' lending criteria to allow borrowers whose repayment vehicle is the sale of the property to take a 75% loan-to-value (LTV) mortgage. Previously borrowers using this method of repayment were restricted to 50% LTV.

However, there are a number of stipulations. Firstly, the part-and-part split cannot exceed 50% on interest-only and borrowers must meet Barclays' minimum income requirements. These are quite high: sole applicants must earn at least £75,000 and for joint applications borrowers must either earn £100,000 between them or one applicant must earn £75,000.

Last month saw Leeds Building Society start to offer some interest-only mortgage deals.

Customers looking to borrow up to 50% LTV with Leeds BS can have the whole mortgage on interest-only. You'll need an acceptable repayment strategy – Leeds will accept sale of the property on the proviso that it has at least £150,000 equity when you take out the mortgage.

Part-and-part deals are on offer from Leeds up to 75% LTV but the repayment strategy rules are tighter at higher LTVs. For example, the sale of the mortgaged property is not acceptable but you can use the equity from the sale of 'other' properties such as buy-to-lets.

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What you need to be eligible for interest-only

Some industry experts are predicting that other lenders will follow suit and start offering loans which can partly be paid on an interest-only basis.

However, these are likely to come with strict rules. Typically you'll need a decent amount of equity in your property and therefore a low LTV.

Secondly, you'll need a plan in place to repay the interest-only part of the loan. Lenders differ on what they deem acceptable – some will accept sale of the property, or another property, while others don't.

Finally, some lenders will offer interest-only deals to high earners only – Barclays' £75,000 salary stipulation is fairly typical.

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