Changing from an interest-only to a repayment mortgage can be expensive, but financial expert Peter Sharkey has a solution. 

More than 750,000 households are deemed to be at risk of defaulting on their mortgages over the next two years, according to the Financial Conduct Authority (FCA).

The financial regulator revealed that 200,000 households had fallen behind on mortgage payments by the end of last June – and as the nation contends with the highest inflation for 41 years, the FCA’s chief executive Nikil Rathi believes that a further 570,000 households are “at risk of payment shortfalls within the next two years”. In some cases, mortgage costs account for almost one third of household income.

While numbers have fallen over the past decade, figures show that by the end of 2021, the latest year for which data is available, a total of 754,000 interest-only mortgages plus a further 252,000 part interest-only, part-repayment mortgages remained outstanding.

The FCA has previously voiced concerns that a significant number of interest-only customers may not be able to repay the capital at the end of the mortgage and be at risk of losing their homes. The body estimated that a significant proportion of interest-only borrowers would be left with a shortfall of more than £50,000.

Interest-only mortgages have always been popular because they offer a relatively inexpensive route onto the UK property ladder. However, new home-owners often find that their property consumes money at a rate they hadn’t expected. Accordingly, while most people have taken out an interest-only mortgage with the intention of ultimately converting it to a regular, capital-plus interest repayment loan, the longer they leave it, the more expensive the conversion becomes.

Many people simply overlook the fact that they should start repaying at least part of the mortgage. Others become so used to making comparatively low monthly repayments that the prospect of doubling or trebling their monthly mortgage outgoings fills them with dread. 

It's easy to see why. 

Consider the example of a couple with six years remaining on their interest-only loan of £80,000, on which they’re being charged 4.9 percent interest, i.e. a monthly cost of £326.67. Assuming they convert to a regular repayment mortgage for the final half dozen years of their mortgage term at the same rate of interest, the monthly cost would rocket, to £1,309.25, a four-fold increase. That’s a pretty daunting prospect.

Should this method of settling an interest-only mortgage prove too expensive, it might be possible for borrowers to extend their mortgage term, although several lenders are often wary of such arrangements.

Why? Well let’s assume that the lender in the example above will allow the mortgage to be converted to a repayment loan and extended by, say, a further ten years at the same rate of interest. The couple would then have a 16-year mortgage costing £ 610.76 a month, almost double their current loan cost.

It’s worth noting that a sizeable proportion of interest-only mortgages belong to people aged over 65. Given that lenders have upper age limits for mortgages and require details of how a regular, capital-plus-interest loans will be repaid, especially in instances where the mortgage term is extended, it’s reasonable to assume that many retirees or pending retirees struggle to do this.

Downsizing might be the answer for some folks, but certainly not all. Fortunately, there is another possible solution: equity release.

“Releasing some of the property wealth people have accumulated over many years has two advantages: it enables homeowners to replace their interest-only mortgage millstone and, in most cases, ensures they can remain in their own home for life without ever having to make a contractual mortgage payment again – if they choose to,” says Equity Release Supermarket chief executive Mark Gregory.

Equity release has helped thousands of homeowners aged 55 and over to replace their interest-only mortgage and it seems likely that it will continue to offer an alternative means of financing. Figures published by UK Finance show that the number of interest-only mortgages scheduled to mature by 2027 is 334,000.

Homeowners struggling to replace an interest-only mortgage should contact their lenders as soon as possible. Meanwhile, borrowers may also wish to consider comparing current equity release deals by using the smartER research tool at Equity Release Supermarket which analyses more than 450 mortgage plans from across the later life market.

For more financial advice, check out Peter Sharkey’s regular blog, The Week In Numbers.

This column is for general information only and cannot be relied on as financial advice for individuals. Consult your professional adviser.