The pros and cons of an interest-only mortgage for older borrowers

It can be frustrating and confusing trying to work out what’s best to do with your finances in times of plenty. But as the cost of living and higher interest rates continue to scupper many well-laid plans, there is also a lingering lack of trust in financial services among older generations.

In October 2023, our annual survey showed that nearly three out of five (59 percent) people between the ages of 50 and 79 distrust financial service providers. It was the same story in October 2022, when we found a 58 percent trust deficit.

This practical guide to interest-only mortgages aims to be as impartial as possible. We want to provide you with the information you need to make the right decision for you, personally, when it comes to considering an interest-only mortgage in your 50-plus or later years. And remember, you don’t have to be a spring chicken to get an interest-only mortgage; you can secure a standard one up to 80 years old, while a retirement interest-only mortgage has no age limit.

Interest-Only Mortgages - the Basics

There are two parts to a mortgage:

1. The capital – which is the money you borrow
2. The interest – which is the money your lender charges you on the amount you owe

What is an interest-only mortgage?

An interest-only mortgage is one where you make monthly payments to your mortgage lender, paying the interest on the lump sum you borrowed against your property. It does not include payments towards the principal balance – or capital – of your loan – just the interest on it.

So, you choose the term – or duration – of your loan and pay the interest each month on the amount you’ve borrowed. When it comes to the end of your term, you still owe the capital. For example, say your home cost £250,000, you paid a £50,000 deposit and took out a £200,000 interest-only mortgage. At the end of your term, you’ll still owe £200,000.

What’s the difference between an interest-only mortgage and a repayment mortgage?

With a repayment mortgage, you pay off the capital alongside the interest, in one monthly payment. With an interest-only mortgage, you pay off the interest on the capital, not the capital itself.

Who is an interest-only mortgage suitable for?

Interest-only mortgages are most suitable for people who want to:

• Buy a new property
• Remortgage an existing loan
• Generate funds for home improvements, lifestyle or to start a Bank of Mum and Dad or a Bank of Grandma and Grandad

An interest-only mortgage could also be suitable for you if you want to:

• Plan your inheritance tax (IHT) for wealth management
• Stay in your property in the short term before downsizing or while waiting for an inheritance payout

Or f if you need to:

• Bridge to a retirement interest-only (RIO) mortgage or lifetime mortgage, like equity release, because either you don’t yet qualify for either of those types of mortgages, or you aren’t yet ready for them. If you take this option, make sure to note if there are any early repayment charges for early exit from the mortgage, as this may mean this is not appropriate for you depending on your circumstances.

The pros and cons of an interest-only mortgage in retirement

Because you’re only paying the interest, an interest-only mortgage may seem cheaper. However, if you reach the end of your mortgage term and you can’t repay the loan in full, in theory, your lender could repossess your home. However, your broker – or a specialist later life lender – may well be able to offer you another interest-only mortgage or switch you to a retirement interest-only (RIO) mortgage or a term interest-only mortgage. More on that later.

Back now to standard interest-only mortgages.

The advantages of an interest-only mortgage for the over 50s

Cheaper monthly payments

Monthly payments on an interest-only mortgage are cheaper than on a repayment mortgage as you only pay the interest – not the capital plus interest.

You could potentially borrow more

As monthly payments are lower, you could potentially borrow more money, or buy a more expensive home.

You could switch

If you want to start paying off the capital and can afford it, you could switch to a repayment mortgage. Or, if you’re later on in life, you could move to an equity release product.

The disadvantages of an interest-only mortgage for the over 50s

You still need to pay off the capital

Because you’ve only been paying off the interest, when you reach the end of an interest-only mortgage, you still have to pay the original loan back. So, it's important to have a repayment exit strategy in place. More on that in a moment.

You could end up a mortgage prisoner

A worst-case scenario is where you can’t pay off the capital on your mortgage, you can’t afford to downsize, and you’ve been moved onto your lender's Standard Variable Rate (SVR) which, in October 2023 was at nearly nine per cent. This can leave you trapped in your mortgage; a mortgage prisoner. Or worse – if you can’t make the interest payments, you could lose your home.

But don’t panic. There are potentially some great options for many so-called mortgage prisoners, who don’t know about the other options available to them.

Penalties for redeeming your interest-only mortgage

Another disadvantage is that if you pay off – or redeem - your interest-only mortgage early, you’ll find yourself with a repayment penalty charge from your lender. On the maybe bright side, the later you pay off your mortgage, however, the lower the repayment penalty charge. And after a stipulated number of years, there’s no charge at all. 

You will need a bigger deposit

For an interest-only mortgage, you will need a deposit of at least 30 per cent of the property value.

The whys and wherefores of a repayment plan

Why you need a repayment plan for an interest-only mortgage

Because the monthly payments on an interest-only mortgage only cover the interest on the amount you borrowed, you will need to have a plan for how to pay off the capital (the amount you borrowed).

You will need to demonstrate the validity of this plan to your lender, who will check at least once during your mortgage term that your repayment plan is on track to pay off your mortgage when it comes to the end of your term.

What does a repayment plan look like?

Note, this is not something that a lender will do for you. You are responsible for setting up and maintaining a sensible plan so that you can repay the original loan at the end of the term.

These plans have to be concrete, without relying on the future promise of some kind of windfall, bonus or inheritance. Similarly, you can’t bank on the value of your property increasing, which may allow you to downsize and still pay off your mortgage.

Instead, examples of repayment vehicles to be taken into consideration include:

• Pensions
• Regular savings plans (endowment policies)
• Cash saved in a savings account including a tax-free individual savings account (ISA) (although some lenders are no longer accepting this)
• Stocks and shares ISA 
• Sale of property
• Shares, investment bonds, unit trusts
• Other properties or assets – these can even be abroad

What is a retirement interest-only (RIO) mortgage

If you still need to pay off your interest-only mortgage when you reach retirement, another option is a retirement interest-only (RIO) mortgage. It works in much the same way as a standard interest-only mortgage, in that you continue to make a monthly interest payment to your lender. The key difference, however, is that the loan – or capital – will only be paid off when you sell your home, move into long-term care or pass away.

Be mindful, however, if leaving a sizeable inheritance is a priority for you. The mortgage lender is entitled to the outstanding value of the loan when your property is sold.

Some mortgage lenders, like LiveMore, make RIO mortgages available to people from the age of 50, retired or working.

Confused? If you have any questions or just want to speak to someone helpful, call or email us via the contact details below.

In the meantime, you can quickly find out if you’re eligible for our variety of mortgages aimed at the older generations in various financial situations, by using our mortgage calculator.

It’s quick and easy. Takes five short steps.