A mortgage is a loan secured against your home. Your home may be repossessed if you do not keep up repayments on your mortgage or any other debt secured on it.
Most loans come with interest, making it impossible for banks or financial institutions to offer loans for free. When obtaining a mortgage or any loan, it’s crucial to make wise choices regarding the interest rates that suit you best. These rates can vary with fluctuations in the current base rate, which makes it essential to stay informed.
In this case, this could lead to an immediate increase in the bill. Understanding interest rates before getting a mortgage is crucial. To enhance comprehension, this article will provide tips on calculating interest-only mortgages.
What Is Interest Only Mortgage?
In a traditional loan, the borrower gradually repays the principal (the money borrowed) and the interest (the amount it cost to borrow the money). This is slightly different from an interest-only mortgage.
Once borrowers take out an interest-only loan, they are given an initial grace period, during which they do not have to make principal payments. Instead, they only make interest payments during that period. The borrower then has to repay the loan in full, either in a lump sum or in monthly instalment after the grace period ends.
Interest only mortgages are primarily designed for borrowers who want to benefit from the purchase funded by the loan. For example, if you are selling your house, you may take out an interest-only loan to buy a renovated house, as you plan to sell the house at a higher price later.
How to Calculate Interest Only Mortgages
Many folks find themselves a bit befuddled when it comes to working out the figures for an interest-only mortgage. Truth be told, you needn’t crunch the numbers yourself. Numerous websites offer handy calculators that can do the job for you, including crunching the numbers for your mortgage.
As an example, you can use the mortgage calculator on Your Mortgage Expert. It’s wonderfully straightforward and practical—all you’ll have to do is input the property value, deposit, interest rate, and mortgage term.
Once you’ve filled in all the details, just hit ‘calculate‘.
An alternative method to compute interest-only mortgages involves employing Excel. It does tend to be a tad more intricate compared to the earlier approach.
However, fret not as there are plenty of ready-made templates available, saving you the hassle of creating the calculation formula yourself. Here’s an example if you opt to utilise Excel for calculating an interest-only mortgage:
As evident, the outstanding debt stands at £150,000. At an interest rate of 6%, you’d take £150,000, multiply it by 6%, and then divide the result by 12. This equates to £750, representing the interest due for payment.
The Good and Bad About Interest Only Mortgage
Interest-only mortgages bring along their array of advantages and disadvantages, and their suitability depends on your distinct financial circumstances and goals. Let’s explore the upsides and downsides of interest-only mortgages:
A. Advantages of Interest-Only Mortgages
1. Lower Initial Payments
Interest-only mortgages offer lower monthly payments during the initial period of the loan. This can be advantageous for borrowers who need to manage their short-term cash flow or allocate funds to other investments or financial goals.
These mortgages offer increased flexibility in handling your finances. When feasible, you have the option to pay more than just the interest, aiding in diminishing the principal balance and lowering overall interest expenses.
3. Investment Opportunities
By utilising the funds saved from reduced monthly payments astutely, like investing in higher-yield ventures or a business endeavour, there’s potential to yield higher returns compared to the mortgage interest rate. This could be a shrewd financial strategy for individuals with confidence in their investment selections.
4. Tax Deductions
In some countries, the interest portion of mortgage payments may be tax-deductible, offering potential tax relief for homeowners with interest-only mortgages.
B. Disadvantages of Interest-Only Mortgages
1. Higher Total Interest Costs
One significant drawback of interest-only mortgages is their tendency to lead to increased overall interest expenses. As you’re not reducing the principal during the interest-only phase, you might end up paying considerably more in interest throughout the loan’s duration compared to a standard amortising mortgage.
2. Risk of Negative Amortisation
With certain interest-only mortgages, there exists a risk of negative amortisation. This occurs when your payments fall short of covering the complete interest amount, causing your loan balance to potentially increase over time. Consequently, this situation might result in owing more than your initial loan amount.
3. Balloon Payments
Certain interest-only mortgages might entail a balloon payment at the conclusion of the interest-only term, necessitating you to settle the entire loan balance or consider refinancing. This could pose a considerable financial burden if you’re unprepared for such an obligation.
4. Interest Rate Risk
Numerous interest-only mortgages come with variable interest rates, implying that your monthly payments can vary alongside changes in interest rates. This can render budgeting more intricate and potentially result in increased payments should rates ascend.
5. Limited equity accumulation
Throughout the interest-only phase, you aren’t accruing any home equity. Consequently, you might miss out on potential home appreciation and could encounter limited options for accessing your home’s equity.
Have You Calculated Your Interest Only Mortgage?
Interest-only mortgages can suit specific scenarios, like short-term funding or for those with irregular incomes, yet they do come with inherent risks. Understanding the loan terms fully and devising a clear strategy for handling principal payments post the interest-only phase is vital.
Seeking advice from a financial advisor or mortgage professional is wise to ascertain if this mortgage type aligns with your financial objectives and situation.
If you’re looking to take out interest only mortgages, try calculating with a mortgage calculator to get an idea of the amount you’ll be paying. Mortgage is the right choice for those of you who want to own a house or other immovable assets. But it still has to be with careful consideration.
If you plan to take out a mortgage and need help with it, you can also hire Your Mortgage Expert. With a wealth of experience and a commitment to delivering personalised solutions, Your Mortgage Expert takes the stress out of securing the perfect mortgage.
We pride ourselves on our extensive knowledge of the ever-evolving mortgage market, ensuring that you receive the most competitive rates tailored to your unique financial situation. Contact us for assistance!
What is an interest-only mortgage?
An interest-only mortgage is a type of home loan where you only pay the interest on the loan during a specified period, typically the initial few years. This means your monthly payments cover only the interest charges, and the principal balance remains unchanged during this time.
What happens when the interest-only period ends?
After the interest-only period, you typically transition into a period where you start paying both the principal and interest. Your monthly payments will increase to ensure that you repay the loan by the end of the mortgage term.
Luca BertolinoMortgage Expert
Your Mortgage Experts is led by Luca Bertolino with 20 years experience in financial services and in the property market. Through Luca’s wealth of knowledge and expertise, Your Mortgage Experts have become a trusted adviser that clients have come to rely upon for all their mortgage and protection needs.