An interest-only mortgage gives you cheaper monthly payments on your home loan but you are not actually paying back any debt.
At the end of the mortgage term you will still owe your lender the amount that you borrowed, and now you need to have plans to repay this at the start of the loan.
24-7 Mortgages will reveal what you need to know about interest-only mortgages and the pros and cons of taking one out.
An interest-only mortgage offers a cheaper way to purchase a property than with a capital repayment mortgage, because borrowers are only paying off only the interest and not the capital.
For example, a £150,000 home loan at 5 per cent over 25 years would cost £625 per month interest-only, and £877 per month capital repayment.
But at the end of the mortgage term, the interest-only loan will have paid off only the interest - leaving the original £150,000 debt to be repaid, whereas the repayment mortgage would have cleared the debt.
Interest-only mortgages are nothing new and were extremely popular in the heyday of endowment policies, which were sold as repayment vehicles alongside them. They are also used by buy-to-let investors, who can claim tax back against mortgage interest.
Previously interest-only mortgages were mainly combined with an endowment policy designed to pay off the mortgage debt and this was considered a lower cost way of buying a home combined with long-term investment benefits.
But as endowments performed badly and fell out of favour from 2000 onwards, they began to increasingly be taken out by buyers who were struggling with affordability.
This has made many lenders steer clear of lending on an interest-only basis.
New regulatory requirements brought in under the Financial Conduct Authority's Mortgage Market Review stipulate that lenders can provide interest-only mortgages only if there is a credible strategy for repaying the capital.
Borrowers will now face tough questions on their income and spending to assess their affordability and if they can cope in the event of interest rates rising.
This paints a very different picture in terms of assessment when it comes to re-mortgaging for those borrowers with interest-only mortgages taken out in the boom. There is now a concern that when interest rates rise and standard variable rates increase, they will find themselves with never decreasing mortgages, stuck on expensive SVRs, and with no way of repaying their debt, especially if their property has fallen in value.
Interest-only mortgages have been the Elephant in the room for the UK property market for some time, described by some as a 'ticking time-bomb' that could leave borrowers with debts that they cannot repay and homes stuck in negative equity.
As the property market continued to boom from 2000 to 2007, the percentage of borrowers taking out interest-only mortgages steadily climbed. By 2007, 33% of mortgages being taken out were interest-only, CML statistics show, and the vast majority have no repayment plan.
This rise in interest-only mortgages is especially troubling as it came at a time when people were borrowing bigger and bigger amounts and endowments, the traditional investment promoted to repay an interest-only mortgages, were dying out. Essentially there are a lot of borrowers whose main plan for clearing their mortgage is that house prices keep rising.
Many people took on an interest-only loan as either first-time buyers or next-time buyers, with the intention of switching to a repayment mortgage later on, but anyone considering doing this should beware of the pitfalls.
It is easy to get used to a certain level of repayments and keep putting off paying the extra - meanwhile the cost is mounting. The other problem is that if house prices don't rise, you will not gain any equity in your home and are effectively simply renting from the bank.
Interest-only mortgages were very popular during the 1980s and 1990s when they were taken out in conjunction with a with-profits endowment policy - an investment vehicle that also featured a life insurance element.
However, many homeowners were promised that the endowment would not only pay off the mortgage but provide a lump sum, too. As endowment funds were dependent upon the performance of their investments some poorly managed funds failed to deliver and left homeowners with big shortfalls.
This led to the mis-selling scandal, as millions found out guarantees offered by advisers and companies were not fulfilled. The mis-selling scandal led to the end of the endowment industry's huge popularity.
It is still possible to take out an interest-only mortgage and use an investment vehicle, such as an Isa or fund, to build up the amount needed to pay off the debt. However, after the endowments scandal many borrowers are wary of using risk-based investments to cover the cost of their home.
A buyer taking out a 25-year mortgage, at 5 per cent, on £150,000 then switching to a repayment mortgage for the rest of the term after five years would pay £625 per month for the first five years but £1,003 per month after that. Not only is the jump in monthly payments large, but they would also hand over an extra £12,019 in interest to the lender.
High prices in some areas, particularly London and the South East, mean that sometimes an interest-only mortgage can be cheaper than renting.
While you may not be paying off the capital, you do own your own home and are on the property ladder. As long as you switch from interest-only to repayment as soon as possible and try to save any extra cash to help cover the costs then it can work.
If prices go up then you will be ahead, but if prices fall you end up owing more than your home is worth and could ultimately face repossession. Experts warn that borrowers who never pay off their debt are simply renting from the bank or building society.
If you have an interest-only loan you should work out your finances and see if switching to a repayment mortgage is possible. Our mortgage affordability calculator can help do the maths. If you are locked into a deal period and will be charged early repayment charges for switching then try to save the difference between the two options, or as much as you can, in a high-interest account.
If you cannot switch to a full repayment mortgage then most lenders will offer a part repayment, part interest-only loan, which means you are at least paying off some capital. To see real benefit make sure the repayment is the larger split.