Interest-only mortgages: Warning against over-optimism in clearing debts

Some mortgage borrowers who only pay the interest on their loan are being "overly optimistic" about their ability to clear their final debt, data shows.

Interest-only deals require borrowers to have a plan to pay off the loan - known as the capital - at the end of the mortgage term.

But research by the Financial Conduct Authority (FCA) suggests some people do not realise they face a shortfall.

The warning comes as rising costs mean interest-only deals may become popular.

They have become an option for some people who think they will struggle to make higher monthly repayments on more widely-used repayment mortgages, in which borrowers pay off both the interest and the capital.

David Geale, director of retail banking at the FCA, said that a final plan to pay off the capital was "a challenge" for some interest-only borrowers.

"Taking an interest-only mortgage can mean lower monthly payments, but borrowers need a plan to repay the outstanding balance when the mortgage comes to an end." he said.

More than eight in 10 (82%) of interest-only customers were confident in their ability to cover the final cost of the mortgage, the FCA survey found.

While 36% said they might have a shortfall in funds when it came to making the final payment, the FCA estimated that the actual figure was likely to be 46%.

What happens if I miss a mortgage payment?

• If you miss two or more months' repayments you are officially in arrears

• Your lender must then treat you fairly by considering any requests about changing how you pay, such as lower repayments for a short time

• They might also allow you to extend the term of the mortgage or let you pay just the interest for a certain period

• However, any arrangement will be reflected on your credit file, which could affect your ability to borrow money in the future

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The FCA data show there were just under one million borrowers with interest-only mortgages at the end of last year - half the number seen in 2015.

Typically, those borrowers were aged 56 and had an outstanding loan of £140,000 that would mature in eight years. These borrowers are typically older and owe slightly more than repayment mortgage customers, who are aged 43 on average and will pay the loan off over the course of 19 years.

The crunch point will come in the next decade, with the greatest number of interest-only mortgages set to mature in 2031 (72,000) and 2032 (77,000), with a smaller peak in 2027.

London accounts for 21% of these deals, followed by the South West of England with 13%, the South East of England with 12%, and the East of England with 10%.

Many interest-only borrowers have a substantial amount of equity in their homes, making a final payment easier if they sell and downsize.

The FCA said that borrowers without a repayment plan should speak to their lender to discuss their options.

This would not affect your credit rating, and steps could be taken now to provide a greater range of options at the end of the mortgage term, such as switching to an alternative loan.