The return of the interest-only mortgage

Most lenders have turned their back on interest-only mortgages. But Yorkshire and Clydesdale Banks have unveiled a new limited-time interest-only mortgage.

Clydesdale and Yorkshire Banks have shaken up the mortgage market with the launch of a Low Start mortgage deal. Payments are cheap for three years, but then soar by 180%.

The deal has raised eyebrows in the mortgage industry because the reason the payments are so cheap to start with is that they are interest-only.

This means the borrower won’t be repaying any of the capital borrowed when they took the loan out.

We’ve taken a look at how the Low Start mortgage works and the pros and cons of this kind of deal.

Interest-only for three years

There are several options for borrowers looking for a Low Start deal with Clydesdale and Yorkshire Banks, both owned by the National Australia Bank.

If you have a 40% deposit (or equity) you can get a three-year fixed rate at 2.69%. The rate is 3.09% if you have a 30% deposit, 3.19% if you have a 25% deposit or 3.69% for a 20% deposit. A £999 fee applies in each case.

Payments are interest-only for three years. After that borrowers are then moved onto the bank’s standard variable rate (SVR), which currently stands at 4.95%, and then repay the loan on a repayment (capital and interest) basis for the remainder of the term.

This kind of deal might appeal to first-time buyers or home-movers who need extra cash to do up or furnish their property in the first few years of ownership.

Payment shock

The trouble with this kind of deal is that borrowers will get used to low payments and be in for a shock when their monthly repayment shoots up.

Someone with a £150,000 mortgage and 40% deposit would pay an initial rate of 2.69% on an interest-only basis for three years. This would mean a perfectly manageable monthly payment of £336 a month.

But once the three years are up they’d be hit with the double whammy of both a rate rise and the effect of having to pay the interest and part of the capital each month. Payments would rise to £945, almost treble the initial payment.

The payment shock is smaller, but still significant, for those with lower deposits as they start on a higher rate. Assuming a £150,000 mortgage, someone with a 20% deposit paying an initial rate of 3.69% would see payments more than double from £461 to £945 when the interest-only period ends.

The problem with interest-only

Interest-only mortgages have become a big area of concern for the mortgage industry. When the market was at its peak in 2007, millions of borrowers took out interest-only loans.

As the name suggests, payments on this type of mortgage just cover the interest owed. At the end of the term the borrower will still owe the capital they originally borrowed.

Ideally interest-only borrowers will have a plan in place to pay off the capital, such as an endowment or ISA. But some people simply rely on property prices rising or an expected inheritance to pay off the capital.

The Financial Conduct Authority has clamped down on the sale of interest-only mortgages, which means it’s now relatively difficult to get one on the high street.

The Low Start mortgage: friend or foe?

So, assuming you meet the criteria and have a decent deposit, should you opt for a Low Start mortgage?

Clydesdale and Yorkshire Banks argue that the deals are good for people who would find it useful to make lower payments for a period of time. First-time buyers, for example, might find the extra cash useful to buy things for their new home. Meanwhile, professionals on a planned career path might be confident of a decent pay rise in three years’ time.

There will also be the option to remortgage to a better deal in three years’ time – although you won’t be able to take another Low Start mortgage with Clydesdale and Yorkshire.

However there are a few unknowns that might make people think twice before opting for this kind of deal. If interest rates go up (or even if they don’t) Clydesdale and Yorkshire might decide to up their SVR. This will mean an even bigger payment shock at the end of three years.

Ultimately there are also better deals on the market which offer cheaper rates and more security. So make sure you shop around and take professional advice before choosing a mortgage deal.

See the latest mortgage rates and get expert advice

This article aims to give information, not advice. Always do your own research and/or seek out  advice from a regulated broker (such as one of our brokers here at Lovemoney), before acting on anything contained in this article.

Your home or property may be repossessed if you do not keep up repayments on your mortgage.

More on mortgages:

Interest-only mortgages: the banks that will still lend

The “cheapest” ever mortgage… with a £2k fee

Leeds launches new mortgages with initial 0% interest period

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