moneysupermarket.com admits interest-only concerns

Amanda Jarvis

April 20, 2006

When it’s in your best interest to repay your mortgage
• As house prices rise 41% in four years, interest-only mortgages double amongst first time buyers for same period
• moneysupermarket.com warns relying on interest-only mortgages can cost up to £12,000*

With the average house price up 41% in the last four years, it’s not surprising that interest-only mortgages are growing in popularity.

However, while the lower monthly payments mean these types of mortgage can be tempting – especially for first time buyers – price comparison website moneysupermarket.com warns consumers only to consider an interest-only product if they are disciplined enough to put money aside to ensure they can repay the debt at the end of the term.

Figures which show the percentage of interest-only mortgages taken out between 2002 and 2005 nearly doubled amongst first time buyers indicate many first time buyers may regard interest-only as the only way to get their feet on the housing ladder. In addition, anecdotally there are signs that with house-prices rising so rapidly first time buyers are neglecting to set up additional savings vehicles to offset the overall debt, instead relying on the hope that the value of their property will have risen enough to cover the debt by the time they want to move again. If house prices stagnate, or even crash, then the consequences could be disastrous.

Consumers should ensure they consider the consequences of an interest-only mortgage over the longer term. Today’s interest-only mortgages do not, unlike endowment mortgages, require confirmation that a separate savings vehicle be set up to cover the eventual debt. Indeed, the lender maintains no legal right over these additional savings plans and as such it is left up to the borrower whether or not they actually put a savings vehicle in place. moneysupermarket.com figures below show that relying on house-price growth to fund a mortgage can add as much as £12,000 to the long-term cost of a mortgage, when compared with a repayment option.

Louise Cuming, head of mortgages at moneysupermarket.com, says: “I would whole-heartedly urge consumers to think carefully before taking out an interest-only mortgage – even if they are attracted by the lower monthly payments. People should only consider this type of mortgage if they are sure they will be disciplined enough to save money elsewhere – as well as setting aside any additional lump sums of cash, like bonuses — and not touch it! Playing catch-up will be much more difficult in the future and the increased monthly payments, when switching to repayment, are likely to be a shock too.”

moneysupermarket.com’s research shows that the longer you remain on an interest-only mortgage, the larger the monthly payments will be when switching to a repayment mortgage. This sounds obvious enough, but over the long-term you are paying over the odds. For example, on a £150,575mortgage over 25 years paying interest-only for the first five years with the Co-Op Bank (term tracker at 4.99%) means monthly payments of £627.80. Switching to repayment after the five years means monthly payments increase to £995.53 — an increase of over £350. Had the mortgage been based on repayment from the start, monthly payments would have been £881.70 throughout. In fact, looking at the repayments over the whole 25 year term, you will have saved nearly £12,000* by sticking with a repayment mortgage from start to finish.

Louise continued: “If a homebuyer can afford to repay their mortgage from the off, then I would urge them to consider this option seriously. If consumers feel they have little option but to take out an interest-only mortgage there are two key factors they need to remember. Firstly, these types of mortgage should only be considered as a short-term option and secondly, the lower repayments should encourage borrowers to save any surplus cash — in turn this should be applied to the overall debt. If you thinking of taking out an interest only mortgage and recognise that you will be financially stretched by this monthly payment, then I urge you to reconsider if now is the right time for you to buy at all.”

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