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Repayment Vehicles for Interest Only Mortgages

You know that your mortgage lender will need proof of an exit strategy to approve an interest-only mortgage - but what repayment plans will they consider viable, and what evidence will you need to submit?

Almas Uddin
Almas Uddin

Founder and Mortgage Advisor

Almas Uddin2023-05-09
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Different Strategies for Repaying Interest Only Mortgages

Interest-only mortgages are an option for house buyers who have a deposit and want to get onto the property ladder but need to keep their monthly payments to a minimum.

As an interest-only expert, mortgage brokers has compiled this guide to explain the importance of repayment vehicles, and how to plan for the end of your interest-only mortgage term.

For tailored advice and recommendations, give the team a call on 0330 304 3040 or email us at [email protected].

What is an Exit Strategy on Interest-Only Borrowing?

Called a repayment strategy, a repayment vehicle or an exit strategy, this plan is how you're going to pay back the original loan value when your mortgage ends.

Each month you pay the interest, but no capital element, so this becomes repayable in full.

Lenders will need evidence of your repayment strategy before offering you interest-only lending.

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Lenders usually cap the amount they lend at 5.5 times your salary, so it’s unlikely you’ll be able to borrow more than this.

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Can I Get an Interest-Only Mortgage if I'm Not Sure How I'll Repay it?

No, lenders need to know what the repayment strategy is and assess the viability, before offering a mortgage.

Landlords, however, don't usually need an exit strategy for an interest-only buy to let mortgage, since this is based on the resale of the property at the end of the term.

What's the Best Repayment Strategy for Interest-Only Lending?

Repayment vehicles are essential since a lender needs to be sure they aren't lending irresponsibly to a borrower who will not be able to repay the loan.

Some of the most common repayment strategies include:

  • Pension fund withdrawals.
  • Selling the property - or another portfolio property.
  • Selling stocks and shares, or cashing in investments.
  • Using savings such as an ISA.

Using Savings or an ISA as a Repayment Vehicle - some lenders do not accept ISA savings as a repayment strategy, so sometimes it is advisable to invest those funds in a more acceptable product.

The challenge is in working out the expected returns on your savings to arrive at an estimated value as at the end of the mortgage.

Selling Stock and Shares - a lender will need to see documents such as statements, or share certificates to verify that you hold the assets being used as your repayment vehicle. In some cases, a lender will work on up to 80% of the asset valuation to hedge the likelihood that it will not be worth 100% of the current value at the end of the term.

Other lenders work on the full projected value, whereas others will not consider anticipated returns, and only accept stocks or shares at 50% of their present valuation.

Cashing in Investments - as with selling stocks, a lender will need to see the paperwork for bonds or unit trusts to consider them a viable repayment strategy.

Endowment Policies - few lenders accept endowment policies as a repayment vehicle, given the potential for the policy to fall short on value. Where lenders will accept this, they will usually use three growth projections and take the median value as the anticipated worth.

Pension Funds - in the UK, people over 55 years old can withdraw up to 25% of their pension fund as a tax-free lump sum, which can be used as a repayment vehicle on an interest-only mortgage.

Lenders will need to see a pension statement and may assign a maximum value to projected pension pot values.

Maximum valuations tend to be between 15% and 50%, so you would need a significant pension fund to cover a more extensive property purchase. For example, if you were withdrawing the full 25% tax-free allowance, you would need a pension of between £600,000 and £800,000 to raise funds needed to cover an interest-only mortgage of between £150,000 and £200,000.

Property Sales as a Payment Strategy - another option is to plan to sell the property. If you have accumulated equity, this excess can be used from the sale proceeds to invest in another residence - typically a downsized option.

Lenders will usually place a minimum equity value on a property resale exit strategy, between £100,000 and £250,000.

Investors can also use another portfolio property sale to repay interest-only mortgages. However, most lenders will require a deduction of around 30% to be taken from the valuation to ensure there is sufficient cash to repay the debt.

How Can I Cancel my Interest-Only Mortgage?

There are lots of ways to switch from an interest-only mortgage to another product:

  • Part and Part Mortgages

This product is a blend of a repayment mortgage and an interest-only mortgage, so can offer the best of both worlds.

Part of your monthly payments is allocated towards the mortgage balance, and the other amount is paid as an interest-only element.

The benefit here is that you contribute towards a decreasing loan balance, although you don't need to pay as much per month as with a full repayment mortgage.

  • Remortgaging from Interest-Only to Repayment

You can remortgage an interest-only mortgage onto a repayment product. Usually, the end of the mortgage term is extended, and you use any cash realised from your repayment vehicle in the meantime to reduce the Loan to Value ratio and lower the total amount being borrowed.

As this is a new product, a lender will need to conduct full eligibility assessments.

  • Equity Release

Our final option to mention is a lifetime mortgage, available to people aged over 55 who want to change their interest-only mortgage to an equity release product.

Lifetime mortgages extend a loan to you against your equity, with interest rolled up into the debt.

That means that you don't need to make any repayments at all, but that when you pass away or go into care, the property will be sold with the capital balance and the accumulated interest recouped by the lender.

The issue with lifetime mortgages is that compound interest can be prohibitively expensive, and potentially treble in a 25-year term.

It is therefore vital to consider the impact on your inheritance planning before applying for a lifetime mortgage.

Professional UK Interest-Only Repayment Vehicle Advice

If you're unsure about the validity of your repayment strategy, don't know if interest-only is the best mortgage for you, or want help comparing UK lenders, get in touch.

The Revolution team is available on 0330 304 3040 and offers independent advice about the right mortgage for your circumstances, and which option offers the most cost-effective strategy.

Almas Uddin
Almas Uddin

Founder and Mortgage Advisor

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FCA disclaimer

The content included in our articles, blogs, web pages and news publications is based on information accurate at the time of writing. Note that policies and criteria can change regularly throughout the UK mortgage lending market, and it remains essential to contact the consultation team to receive up to date guidance. The information included on the Revolution Brokers site is not bespoke to any circumstances or individual application scenarios and therefore is not intended to be used as financial advice. The content we share is designed to be informative and helpful but cannot be relied upon to provide individual advice relevant to your mortgage requirements. All Revolution team members are fully qualified, trained and experienced to provide mortgage advice of an independent nature.

We collaborate with lenders and providers who are regulated, authorised and registered with the Financial Conduct Authority (FCA). Should you require specific mortgage borrowing types, some products such as buy to let mortgages may not be FCA regulated. The Revolution team can provide further information about regulated and unregulated lending as required. Please remember that a mortgage is a debt which is secured against your home or property. Your home can be at risk of repossession if you do not keep up with the repayments or encounter any other difficulties in managing your mortgage borrowing responsibly. This also applies to any remortgage or home loan secured against your property, including equity release products.

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