The credit crunch is prompting thousands of people to take out interest-only rather than repayment mortgages. But this could prove a costly mistake in the long run.
At first it will make mortgage costs appear more manageable - as our table below left shows. Yet you could find yourself in a deep financial hole unless you are very strict about saving to repay the capital when the mortgage finishes, or you switch back to a repayment one.
Despite this, 37 per cent of all mortgages taken out in February were interest-only deals, up from 34 per cent last year, according to figures from the Council of Mortgage Lenders. And of these, 27 per cent did not specify if they had set up a savings scheme.
As banks struggle to ride out the economic storm, the average two-year fixed rate is now around six per cent, while only a couple of years ago it was just 4.5 per cent. It means monthly payments on a £100,000 25-year repayment mortgage are £644, while on an interest-only one they are a more manageable £500.
However, you'll end up paying a lot more interest over the term as the capital is not being reduced.
David Hollingworth, of London & Country Mortgages, explained:
"This borrower will pay £150,000 in interest over the 25 years, whereas if they had the mortgage on a repayment basis, they would only incur £93,290 in interest over that period."
So if you are really struggling to meet the cost of your mortgage, rather than switching to interest-only check to see if you are eligible for a break from your monthly payments.
Sean Gardner, of MoneyExpert.com, said:
"Banks want to know if you're under the cosh now and intend to do something, rather than wait until you're defaulting."
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