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Your options if you're struggling to pay off your interest-only mortgage

lovemoney staff
by Lovemoney Staff lovemoney staff on 02 May 2013  |  Comments 22 comments

As a new report highlights how hundreds of thousands of people face a shortfall in paying off their interest-only mortgages, here's what you can do now if you're worried about yours.

Your options if you're struggling to pay off your interest-only mortgage

Hundreds of thousands of interest-only mortgage borrowers face a "ticking time bomb", with either no plan on how to pay off the capital they have borrowed or a plan that is not on track to clear their debt.

That's according to a new report from regulator the Financial Conduct Authority (the successor to the Financial Services Authority). Its research found just under half of borrowers whose interest-only mortgage ends in 2020 are facing the prospect of not being able to pay off their mortgage in full. And a third of those borrowers need to find more than £50,000.

The boom in interest-only mortgages

With a repayment mortgage, you repay a little of your debt each month, on top of interest. So by the time your mortgage expires (usually after 25 years), your debt is completely paid off. On the other hand, with an interest-only loan, you pay only the interest on your debt. Of course, if you don't have the money to pay off the remaining capital debt after a quarter-century, then you have an almighty problem.

As house prices soared in a 12-year boom lasting from 1995 to 2007, buying a home became ever more expensive. As a result, more and more homebuyers became unable to afford the higher repayments required by repayment mortgages. So they opted for the interest-only option instead.

Interest-only loans are inherently riskier, because they allow borrowers to have a huge debt hanging over them with no sure means of repayment.

But as house prices soared, lenders put these worries to one side and lent recklessly to borrowers via interest-only loans and 100% (no deposit) mortgages.

What can badly hit borrowers do?

Clearly, a large number of borrowers are in trouble. Some have interest-only loans with no visible means of repayment, some are in negative equity (where their outstanding mortgage is larger than the value of their home), and many are struggling to pay their monthly mortgage repayments in full.

So what can you do if you're a struggling mortgage borrower?

1. Contact your lender now

Be pro-active by contacting your lender as soon as you start having difficulty meeting your monthly repayments. If you drag things out and turn a setback into a crisis, then your lender will be far less lenient and understanding.

Ask your lender for a copy of its official arrears, forbearance and repossession policies, so you know how it can help you.

You will probably be offered the option of switching to a repayment mortgage, but bear in mind this is likely to be much more expensive, certainly in the short term. You might also be offered the option of extending the term of your mortgage by, for example, another five years.

2. Pay vital bills first

When times are tough and money is short, you must pay priority bills first. To keep a roof over your head, avoid fines and stay out of prison, pay THEM FIRST, which stands for:

  • Tax (council)
  • Hire purchase
  • Electricity and gas
  • Maintenance and child support
  • Fines
  • Income Tax
  • Rent or mortgage
  • Second mortgage
  • Television licence

Every other bill – including unsecured loans and credit cards – should be ignored in favour of these core bills.

3. Lengthen your term

Increasing the term (duration or life) of your home loan won't reduce your repayments if you have an interest-only mortgage. Nevertheless, it will give you extra time – perhaps five years or more – to make new arrangements to begin repaying your loan (and any arrears) as and when your personal finances improve.

4. Reduce your repayments

If you can't meet your full monthly repayments, then simply pay what you can. But get agreement from your lender first. You will need to give your lender a complete breakdown of all your income and outgoings, assets and debts.

The more you can pay each month, the more likely your new payment schedule is likely to succeed.

5. Start a repayment plan

Once your situation improves, don't stop planning ahead after any arrears are paid off and your mortgage account is up to date again. Instead, take steps to create a proper plan to repay your entire loan when it ends. Otherwise, you may have to sell your home to pay off this debt.

6. Seek state help

State support for homeowners is very limited, but you may be able to claim Support for Mortgage Interest (SMI). This is a benefit paid to mortgage borrowers who get income-related benefits such as Income Support, income-based Jobseeker’s Allowance, income-related Employment and Support Allowance, and Pension Credit.

Note that SMI provides help only with mortgage interest, not capital repayments, and is paid at a standard rate (currently 3.63% a year). It's also extremely difficult to qualify for and is paid for up to two years.

7. Sell up and downsize or rent

Finally, one reason why lenders don't repossess more homes is that they actively encourage some borrowers to sell up, rather than have their properties seized. For struggling borrowers with some equity, this can be the best or only solution to ongoing payment crises.

Tough though it may be to accept, always remember that there is no shame in selling up and downsizing or renting, especially in these difficult times.

This article has been updated since it was originally published

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Comments (22)

  • PDB11
    Love rating 72
    PDB11 said

    Every other bill -- including unsecured loans and credit cards -- should be ignored in favour of these core bills.

    What happened to the old maxim "Most expensive debt first"? OK, I agree loans secured on things you can't afford to lose, such as your house, are a priority, but television licence? If you're in that much trouble, sell the telly and get rid of the TV licence altogether. Seriously.

    OK, I know it's easy to tell people to give up something if one does not onself indulge; and watching telly holds little or no interest for me. But is watching telly really worth the licence fee? Is it really worth the licence fee plus the cost of the TV set? A good TV set costs what, £800 these days? And lasts five years? That's another £160 a year just for having it, more than the cost if the licence. Together, they come to over £300 a year, or £25 a month. If you are struggling - and I mean really struggling - with debt, think seriously about giving up the TV habit.

    Report on 01 August 2012  |  Love thisLove  0 loves
  • easygoing
    Love rating 156
    easygoing said

    PDB 11 If you have paid £800 for a decent TV these days you were robbed! It is easy to say give up your TV but even discounting the harassment from the TV License Records giving up TV can be a bad move. I don't agree with people who say that there is nothing to watch these days. There is plenty if you broaden your horizons. It is just fashionable to knock TV.

    Depriving children from something their peers have and enjoy is likely to cause them social problems at school. As for the adults, why make life even less enjoyable. I don't see how making one possible diversion from the misery is really worth the savings.

    As for those out there, keyboard poised, to say the should read a book etc. everything has a cost even books. Don't mention libraries as they are hard to find these days.

    Report on 01 August 2012  |  Love thisLove  3 loves
  • jonnie2thumbs
    Love rating 90
    jonnie2thumbs said

    If things got tough I would prefer to buy food for my family.

    Report on 01 August 2012  |  Love thisLove  0 loves
  • Henry-GBG
    Love rating 46
    Henry-GBG said

    Surely the simplest way is to allow the mortgage to be converted into a straightforward tenancy at the end of the period? Borrowers are to all intents and purposes tenants anyway.

    Report on 01 August 2012  |  Love thisLove  2 loves
  • yocoxy
    Love rating 132
    yocoxy said

    I would imagine that the term will just be extended, they'll continue to pay interest until they can repay the loan or until they die at which point the property would be repossessed.

    Isn't this just the same as paying rent for life and having no asset to bequeath? (Only cheaper).

    In fact, I think if my kids were ever to ask if they should rent or take interest only mortgages, I'd recommend the mortgage on the basis that it gives them an absolute right to buy or chip away at the debt at any time. If I'd have done that as a youngster, I'd have had much more disposable income (read 'at least some' :-)) in my early marriage and for the price I paid for that first house, I could now pay for it three times over from savings.. I'd only need to find 17K at this stage and could sell it tomorrow for 150K.

    Report on 01 August 2012  |  Love thisLove  0 loves
  • nickpike
    Love rating 270
    nickpike said

    There's a lot more than 100,000 IO mortgages out there. Many of these will have the same problems as the years go by, so the numbers will grow significantly.

    This whole thing is turning full circle. We're beginning to learn that the strict rules on mortgage lending that were practised 20 years ago were there for a reason.

    Report on 01 August 2012  |  Love thisLove  5 loves
  • nickpike
    Love rating 270
    nickpike said

    Yocoxy said

    "Isn't this just the same as paying rent for life and having no asset to bequeath? (Only cheaper)".

    Depends on interest rates. You recommend IO mortgages, but if interest rates shoot up to where they've been before, repayments would be a lot higher than rent.

    Report on 01 August 2012  |  Love thisLove  2 loves
  • t11ggs
    Love rating 3
    t11ggs said

    Buy to let has caused this bubble... time for interest rates to go up and prices to come down ... a lot of people will lose everything ....greed - has to be paid for!

    Report on 01 August 2012  |  Love thisLove  3 loves
  • waggy142
    Love rating 11
    waggy142 said

    I’m surprised that no mention has been made of Life Assurance. Surely anyone taking out an interest only mortgage would be stupid not to invest in an endowment policy which would cover the amount to be repaid at the end of the mortgage term. I had an interest only mortgage along with an endowment policy which covered my loan, and gave me a little extra to enjoy when I paid off the mortgage.

    Report on 01 August 2012  |  Love thisLove  1 love
  • jedi44
    Love rating 31
    jedi44 said

    @waggy142

    Like you, I had an interest only mortgage which I was only given by the bank when I proved that I had an endowment policy to cover the capital. Way back then it was expected to pay me the little bit over that you mentioned. However, more recently, these policies started to fail as has been well-documented. My own policy fell about £8,000 short. I was lucky that I had enough savings over the 25 years to be able to make up the difference. Many of the latest takers of mis-sold endowment policies have received compensation but I'm sure there are plenty out there that will fall into the trap of not being able to claim compensation and not having had the ability to save enough to pay off the capital.

    Report on 01 August 2012  |  Love thisLove  1 love
  • yocoxy
    Love rating 132
    yocoxy said

    @nickpike. The rent on one of my flats is three times the mortgage interest, (despite limited equity) so there's a lot of room for an interest rate rise before renting is cheaper and you're still left with no asset and an obligation to pay for life..

    Report on 02 August 2012  |  Love thisLove  0 loves
  • Paul1
    Love rating 8
    Paul1 said

    @ t11ggs "Buy to let has caused this bubble... time for interest rates to go up and prices to come down ... a lot of people will lose everything ....greed - has to be paid for!"

    I couldn't agree more, you've hit the nail on the head there! The problems were caused by people being able to buy double figures of properties, which obviously meant less for everyone else, which means greed and desperation causes the prices to go up...

    To name some of the many causes of the current problems regarding property on our little island:

    1: The 'buy, buy. buy' attitude of the 80's/90's Conservative government.

    2: Too many people, too little space; meaning many people are screwing each other over for every square foot of space.

    3: Greed! Nobody should be allowed to own more than 2 properties, or there should be large penalties for doing so, making it not so financially attractive.

    Report on 02 August 2012  |  Love thisLove  2 loves
  • edwardmk2879
    Love rating 57
    edwardmk2879 said

    Bring back strict rules on borrowing says nickpike, and I totally agree. These rules protected borrowers from being exploited. Many many folk are financially unsophisticated, and have been led right up the garden path. They will bitterly regret taking out interest only mortgages if that was done later in the game using liar loans.

    I would insist that the repayment plan was agreed before the loan was issued, not relying on automatic 'you can't lose' increases in equity.

    Also, force the lenders to accept that if they foreclose, then negative equity is absorbed by them, and the dispossessed party is not on the hook for tens of thousands despite losing their house. In the USA, many areas allow 'jingle mail' where the hapless 'owner' posts the keys back and cannot be chased by the Bank for the negative equity.

    Mortgage lenders would quickly spruce up their act and be far more sensible with their lending. This would also stabilise the market, creating less boom and bust going forwards.

    Report on 02 August 2012  |  Love thisLove  1 love
  • justjulie
    Love rating 5
    justjulie said

    oh don't get me started on endowment mortgages and that great train robbery !! with 10 years left on a 25 yr endowment mortgage i discovered it was in the ' RED ' zone and was going to fall short by £9000, bearing in mind it was only for £21 grand initially. I challenged the IFA who sold us the mort for a whole host of reasons and got nowhere,primarily as the product was sold less than 1 month before the cut off date that the FSA would get involved..then the company demutuallised and my ex husband got all that windfall as he was first named on the damn mortgage even though every penny was paid out of my salary! then i had to remortgage and swap to a repayment mort and add on enough to cover the shortfall.. I have 3 very well off friends who all have recent new IO mortgages and not one of them has made any provision on how to raise the capital to pay off the interest. One of them is already in negative equity less than 5 years into the mortgage and has sold her endowment and bought jewellery and the other is waiting to sell and downsize and she recieved the backing of the FSA to challenge her IFA to get compensation . Her endowment was sold 20 days after mine !!....she spent the money on a holiday....any way....good days ..i made the endowment 'paid up' 10 yrs ago and its just matured and done a little better than expected....the cash is sat waiting now in a really good place waiting to pay off the interest only bit of my 2nd mortgage in 3 yrs time

    Report on 03 August 2012  |  Love thisLove  0 loves
  • Bonjovi64
    Love rating 0
    Bonjovi64 said

    Please stop moaning at the “buy to let” brigade. The Government sold all the council houses to the parents of the people who can`t get council rented properties now. These people (the parents) are the ones who made a load of money when they sold them on. The BTL people are only renting to their children. As for the Repayment Mortgage, those people who took one out not realising that they would have to pay for their property at the end will only end up renting when they lose their home. Sound harsh but a fact.

    Report on 04 August 2012  |  Love thisLove  0 loves
  • matchmade
    Love rating 38
    matchmade said

    I chose interest-only mortgages from Northern Rock because I had (and have) better uses for my spare capital than paying down the mortgage: I invest the money instead to grow my business and put money into my SIPP and ISAs. IO is a perfectly rational approach to mortgage lending and I wish the moaning minnies would stop nannying and lecturing people to follow their prescriptive methods of handling personal finance. The mortgage market should offer a diversity of methods to pay back the debt, not be restricted to repayment-only just because Nickpike et al think it's best and that the rest of us should obey them. The UK is meant to be a fairly free and capitalist country and people should be treated as adults and allowed to fail as well as succeed. If certain individuals failed to make provision to pay off their mortgage, that's their own fault and they will eventually have to sell off the house and either move to a smaller house or rent. So what if they're near retirement? It serves them right for not planning ahead.

    Report on 05 August 2012  |  Love thisLove  1 love
  • Tanni
    Love rating 91
    Tanni said

    The lenders should have ensured that the borrowers can repay the capital along with the interest. I feel so sorry for those people who maybe forced to be homeless as they cannot raise the capital. I recommend all those on interest only mortgages bring forth a class action against the greedy lenders who neglected to ensure that the borrower can pay back the money. The only winners are the lenders, no surprise there then!

    Report on 06 August 2012  |  Love thisLove  0 loves
  • PensionPlan2
    Love rating 0
    PensionPlan2 said

    I think interest only is a perfectly acceptable way of owning property. Yes the money has to be paid back, but if the borrower is very aware of this at outset then what's the problem? I would rather have an interest only mortgage than rent every day of the week. However in the ideal world at some point when more money is available yes the balance outstanding should be repaid by lump sums or converting to a repayment option. I worked for a company who started to insisit on repayment only, no wonder we all couldn't achieve our targets, and are now at the car boot trying to make a living. "Match made" I hope your pension is good mate because just you wait until the boot is on the other foot.

    Report on 06 August 2012  |  Love thisLove  0 loves
  • justjulie
    Love rating 5
    justjulie said

    sorry to say but its not the lenders fault if a person decides to take an IO mortgage without making provision on how they will eventually pay the debt. From what I can remember no lender would have entertained anyone who had not shown evidence of their repayment means at the outset....its a sad fact that some people either lied or deliberately set out to get an IO mortgage on unscrupulous morals..well woe betide them I would say...and any company who jumps on the bandwagon of another mis selling scandal should be ashamed....as I say...you made your bed now you have to lie in it...

    Report on 07 August 2012  |  Love thisLove  3 loves
  • yocoxy
    Love rating 132
    yocoxy said

    Instead of "no one should be allowed to own more than two properties" why not ban families from having more than two kids? Equally ridiculous in a free society but probably more effective at solving the long term housing shortages that will see prices continue to rise.

    We could add

    No more than two cars (since the roads are busy)

    No more than two workers per family (since unemployment is an issue)

    No more than two doughnuts (since there's an obesity epidemic)

    No more than one political party (since our new communist state will decide who Governs)..

    Report on 08 August 2012  |  Love thisLove  1 love
  • snowbunny2012
    Love rating 0
    snowbunny2012 said

    If you're in a pickle like this you need to think of a serious money earning strategy to start to pay down the capital. One way would be to rent out a spare room or two, to get some serious money coming in every month that you can use to pay down the mortgage. Many people have done this very successfully, and earnings up to £4250 a year are tax free if you rent out a furnished room.

    Report on 02 May 2013  |  Love thisLove  0 loves
  • AFlondon
    Love rating 18
    AFlondon said

    The rest of us will end up paying more tax when these people start crying "mis-selling!" and demanding "compensation".

    Report on 03 May 2013  |  Love thisLove  0 loves

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