Equity release can help pay off an interest only mortgage if you’re coming to the end of your mortgage term and facing a shortfall. However, this depends on eligibility. Releasing equity provides a tax free cash sum to use how you wish, so repaying an existing mortgage is one option.
Around 1 in 5 homeowners use equity release to repay their mortgage. However, these figures could increase as thousands of UK interest only mortgage holders approach the end of their mortgage term. With no adequate repayment strategy in place, equity release offers one option for those making mortgage capital repayments.
According to the Financial Conduct Authority, 40,000 over 65s will come to the end of their interest only mortgage term each year between 2017 to 2032. But with so many facing a shortfall, is equity release the best way to pay off your interest only mortgage?
What is an interest only mortgage?
With an interest only mortgage, you only make monthly repayments against the interest, not the capital. Instead, the capital is repaid once the term of your mortgage ends. This means your monthly payments are less compared to a standard repayment mortgage, however the amount you borrowed initially remains the same.
For example, if you borrow £250,000 over 25 years, you just pay the interest accrued on a monthly basis. Then at the end of the mortgage term, you pay the capital, which in this scenario would still be £250,000.
Therefore, with this type of mortgage, in addition to thinking about your monthly repayments, you also need to have a financial plan in place to repay the capital when due.
Before the 2008 financial crash, it was relatively easy to get an interest only mortgage. You only needed to demonstrate that you could meet the monthly payments, not the actual debt. Therefore, this type of mortgage appealed to many, regardless of their financial status.
Unfortunately, the repayment method for a large percentage of interest only mortgage holders, be it an endowment policy, savings or investment has fallen short. As a result, homeowners and lenders alike are looking for ways to bridge the gap.
How can you use equity release to pay off an interest only mortgage?
Equity release or lifetime mortgage as it’s known lets you access money tied up in your home, which could be used to repay an interest only mortgage. There are no monthly repayments as the loan plus interest are repaid once you die or move into care and the property sold.
Your eligibility for equity release depends on your age and the value of your property. You can apply if you have an existing mortgage however you must use the equity you have released to repay the debt. Any remaining funds are yours to use how you wish.
Should I use equity release to pay off my mortgage?
Using equity release could be a good idea to pay off an interest only mortgage, however it depends on your situation. Equity release will impact your family’s inheritance and could affect any benefits you receive. Therefore, it’s important to consider all mortgage repayment options and seek professional advice.
Other ways to pay off an interest only mortgage
In addition to equity release, there are several ways you could pay off an interest only mortgage:
- Extend your mortgage
- Switch to a repayment mortgage
- Increase your monthly payments
- Switch to a lower interest rate
- Get a retirement interest only mortgage
Get a mortgage extension
You could extend your mortgage, allowing more time to save and repay the loan. However, this will depend on your income and age as most lenders will not extend beyond a certain age.
Switch to a repayment mortgage
By switching to a repayment mortgage, you will repay the interest and some of the capital on a monthly basis. This means there will be nothing left to pay at the end of your mortgage term however your monthly payments will be higher.
Make larger monthly repayments
If you can afford to you could make larger monthly repayments, either on a regular or adhoc basis. This will start to reduce your capital meaning the amount you owe at the end of the mortgage term will be less. Your mortgage lender can advise you the overpayment terms they offer.
Switch to a lower interest rate
Switching to a lower interest rate either with the same lender or a new one will reduce your monthly payments. Therefore, you can use the money to overpay your interest only mortgage, therefore reducing the capital.
As always, your ability to change to a new mortgage will depend on your age and financial status.
Change to a retirement interest only mortgage
Retirement interest only mortgages, like standard interest only mortgages only require monthly interest repayments. The main difference is there’s no term, so no set date to repay the capital. Instead your monthly repayments continue for life or until you move into care. The property is then sold and capital repaid.
As retirement interest only mortgages are designed for retirees, there is usually a minimum age threshold of at least 55. Also, as this type of mortgage is relatively new, not all lenders offer them however an independent financial advisor will advise you on the best course of action.
Downsizing to a cheaper property could help repay your interest only mortgage. However, this depends on your property value and whether it generates enough money to repay the capital. You could move to a cheaper area however if this leaves you feeling isolated, you may want to consider equity release.
The Financial Conduct Authority has also produced a helpful guide to repaying interest only mortgages too.
Frequently asked questions
What happens at the end of the term on an interest only mortgage?
At the end of your interest only mortgage term, the capital, which is your original loan will need to be repaid. So, if you’re original loan was for £200,000, the same amount would need to be repaid.
What happens if I can’t pay off my interest only mortgage?
If you think you may not be able to pay off your interest only mortgage at the end of the term, speak to your lender immediately. It’s important to do this as soon as possible so they can help you review your options.
Is there compensation for interest only mortgages?
If you believe your interest only mortgage was mis-sold, financial compensation may be available. For more information go to the Financial Ombudsman Service website.
Can you release equity with an interest only mortgage?
Yes, can get equity release with an interest only mortgage however eligibility will depend on your age and property value. You will also be required to repay your existing mortgage with the money you release.