What is an interest only mortgage?
Essentially, with interest only mortgage rates, you’re paying the interest on the loan without making any kind of payment on the money that you’ve borrowed. So at the end of the mortgage term you owe exactly what you borrowed in the first place and you’ll have to find a way to pay off this outstanding amount at the end of the term.
Many banks insist on a separate account or a repayment vehicle, where you save to pay the mortgage off at the end of the term. Normally that money goes into a long-term ISA or a stock market-linked account that makes the money work hard for you. Theoretically it can work well, but the whole concept is fraught with risk and that’s why many banks have simply stopped offering them.
There is no certainty that an investment vehicle will make enough to pay off the balance and settle the mortgage, so you could end up with a significant shortfall at the end of the term.
If this was the case with rising property prices, the lender used to be covered. The property crash showed the financial world they simply could not rely on that anymore. If the lender had to sell the property to cover the cost of any shortfall in the loan, it may not cover the outstanding amount.
It can also cost more to take an interest only mortgage, as you pay interest on the whole amount for the whole term rather than gradually chipping away at the money owed and therefore only paying interest on an amount that is decreasing over time. You should always take expert financial advice if you’re considering taking an unconventional approach to your mortgage.