An interest-only mortgage, as the name suggests, is one where no principal repayments are required to be made during the term of the loan. It is usual for an interest-only mortgage to be interest-only for a fixed period of time, such as two years or five years, after which it can either be converted to a table loan (principal and interest) or rolled over as interest-only with the approval of the lender.
The key advantage of an interest-only mortgage is that the minimum repayments are less. They can be particularly useful for:
- First home owners for whom mortgage repayments are a big percentage of income
- Home owners who have a change in circumstances such as a sudden loss of income due to illness, redundancy, death of a partner or birth of a child
- Retirees or others on low incomes who need to borrow money to maintain their property or to cover essential living costs
- Home owners who have a significant amount of short term debt with very high monthly repayments
- Property investors for whom the interest on mortgages is tax deductible
Getting rid of debt on the home you live in should be a priority and so the use of an interest-only mortgage should be a last resort or a temporary measure for when money is tight. For property investors who still have a mortgage on their own home, it makes sense to use all spare cash to reduce the principal of the home mortgage for which the interest is not tax deductible. Property investors for whom the interest on all debt is tax deductible may choose to still leave their mortgages as interest-only and invest the equivalent of the principal repayments elsewhere for a return higher than the net cost of interest after tax.