Mrs M asked:
I have an interest-only mortgage of £91,000 with 11 years left, with no plan to repay it at the end. It was originally a repayment mortgage, but when I couldn’t afford the payments the bank suggested I switch to an interest-only mortgage.
I went through with my bank an option to change to repayment but they didn’t accept me. Can I pay extra each month? Will it reduce the debt and not just the interest?
Interest-only (IO) mortgages are a major problem for hundreds of thousands of people. In 2018 the Financial Conduct Authority has been encouraging borrowers with interest-only mortgages to talk to their mortgage lender about their options. But this reader hasn’t had a very helpful response! Her bank may be right that she can’t afford a repayment mortgage, but what should she do?
I don’t know anything else about Mrs M’s situation but I can look at the typical options that someone may have in her position.
Four main options
With eleven years to go on her mortgage and having some extra money each month, Mrs M has four main options to think about. She is doing absolutely the right thing to look at the problem now – the longer it is left, the less time she has to take action!
Switch part to repayment
The reader’s bank has decided she can’t afford a repayment mortgage. But it may be possible to switch part of the mortgage to be a repayment mortgage. So Mrs M could say get a repayment mortgage for £50k and the remaining £41k could stay on interest only.
At the end of her IO mortgage, Mrs M would still have a problem. But owing less and with more equity in her house she will have better options at that point (new mortgage? equity release? downsize?) than if she does nothing at the moment.
Extend the mortgage
This option is most likely to work for someone whose IO mortgage is finishing some years before retirement. Say Mrs M’s mortgage ends when she is 61 and she expects to work until her state retirement age of 67 (check your state retirement age here). Her bank may think she can’t afford a repayment mortgage of 11 years, but could manage the repayments on a longer mortgage of 17 years.
Overpay the mortgage each month
This is what Mrs M is suggesting – if she can pay extra each month, this overpayment will start chipping away at the size of her mortgage.
Because her mortgage is going down, this in turn will in turn reduce the interest she has to pay, so this becomes a virtuous circle. MoneySavingExpert has a mortgage overpayment calculator which shows how much making overpayments will reduce your mortgage.
If she won’t be able to repay the whole mortgage by the time it finishes Mrs M would still have a problem. But as with the “part repayment” mortgage above, this will be a much smaller difficulty than if she does nothing at the moment.
Mrs M needs to ask her bank if she can make overpayments. If she has a fixed rate mortgage, overpayments are often limited to 10%. For a variable rate mortgage, there will typically be no limit. If she can overpay, she needs to be clear to her bank that she wants all overpayments to reduce the capital, not the term of the mortgage.
The simple way to make these overpayments is to change her standing order that pays the mortgage to a larger amount. But if her income is erratic, she could pay a different amount each month.
Save up the spare money
If none of the above will work, Mrs M can always start saving up the extra money she has each month. Get a “regular savings account” and set up a standing order to fund it each month. If she does this for 11 years, she will have a lump sum she can pay off the mortgage when it ends.
Other ways her situation may change
For all of these options, it’s useful to look at whether there is any way to increase the amount of money that could go to your mortgage and how these could change over the rest of the life of the mortgage. See the “Improve your finances” section in this other article: Options if you have an interest-only mortgage for some ideas.
It’s also good to think about combining options. If her bank will only allow her to have a repayment mortgage for 50k, she could still make overpayments to the remaining IO mortgage.
One of the reasons Mrs M may think she can afford a repayment mortgage and her bank may disagree is because the bank has to think about what will happen when interest rates increase. That will be a problem, but the timing and amounts of any interest rate increases are unknown. Every pound she pays off the mortgage now, when rates are low, will reduce the impact of interest rate rises in future.
What if her bank is wrong?
If Mrs M is convinced she can easily afford a repayment mortgage, she could put in a complaint to her bank and ask them to look again at it an. Or, if she has a good credit record, she could talk to a broker about whether she could remortgage with a different bank onto a repayment mortgage.
Get some help to decide
I’ve just looked at some common options here. It can be hard to make a decision on what to do, especially if your situation is complicated by the possibility of taking some money out of your pension or if you have a lot of other debts to deal with as well as your mortgage.
Pension Wise can give good information about taking money from a pension. Citizens Advice can’t give advice on what mortgage you should get but can help you look at general debt problems and your options for an IO mortgage.
And do talk to your mortgage lender! Even if you feel they will be unhelpful or your situation is hopeless. Your mortgage lender can’t force you to move to a mortgage you can’t afford and they can’t end your mortgage early if you don’t have a repayment plan.