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Taking out an interest-only mortgage can appeal to people who want low monthly mortgage payments. This does involve some risks, as you are not reducing the overall debt on the purchase of your home. If you’re a contractor, there are a few other important considerations to be aware of.
With an interest-only mortgage the monthly payments only cover the interest on the outstanding loan. When the mortgage term ends, you must pay back the loan in full.
Because it can be challenging for people to repay the loan amount, interest-only has become less popular. Banks and building societies must carefully assess your plans to repay the debt – often called a ‘repayment vehicle’.
Interest-only is an option on both residential and Buy to Let mortgages.
Interest-only mortgages may be a good choice in certain situations, but they are also a risky way to borrow. A key risk is that the solution you put in place to repay the debt on the property – an investment portfolio, for example – doesn’t perform well enough to let you repay the loan.
In this situation the property could be repossessed.
Here’s a quick summary of the two mortgage types:
Interest Only Mortgages
Provided you have the required deposit and have researched potential repayment vehicles, getting an interest-only mortgage is no more difficult than a repayment mortgage.
One challenge, however, is that fewer lenders offer interest-only mortgage products, and you may find that your options for a contractor-friendly, interest-only mortgage are limited.
With any mortgage, a lender will do various checks that you can afford to repay the loan. With an interest-only product this will partly focus on your repayment vehicle. The lender will want all the details of how you plan to repay the loan, as well as proof of your income.
In addition, some lenders set a minimum income level for an interest-only mortgage, typically £50,000.
Each lender will view contractors in their own way. Some will accept your day rate and proof of contract as the basis of your income, while others will want to see company accounts and tax records.
Mortgage lenders will want to understand how you will repay the loan at the end of the term. They will ask for specific details and projections. Typical mortgage repayment vehicles include:
In some situations you may be able to repay the loan by selling a property, but this is generally frowned upon by lenders, as property prices can go up or down.
If you are unable to cover the whole mortgage with your repayment vehicle, it’s possible to take out a part-repayment, part-interest-only product. This could work well if it proves challenging to get a suitable interest-only deal.
An interest-only mortgage is no more expensive in terms of interest rates and product fees. The big difference is that your monthly mortgage interest payments are not an investment in the same way as a repayment mortgage.
At the end of your repayment mortgage term, the property is yours, and all your payments have achieved this. With an interest only deal you will still owe the lender at the end of the term.
Some contractors now work through umbrella companies to avoid the implications of the IR35 tax regulations. Not all lenders recognise how umbrella companies work, which may restrict how much you can borrow.
It may help to seek out a specialist Mortgage Lender that will underwrite a loan based on your specific situation, as opposed to a high street lender. A Mortgage Broker can help you explore the options.
It is crucial to fully understand the implications of interest-only before making any mortgage applications. A Mortgage Advisor will explore all the details with you. They will also be able to unearth the most appropriate deals – especially as many products are only available through brokers.
Momentum has a wealth of experience in arranging contractor mortgages.