The Mortgage Charter: Should I consider an interest-only deal?

Interest-only mortgages will temporarily reduce your monthly repayments, but you’ll likely pay more in total at the end of your term.

Last month, the Treasury introduced the Mortgage Charter, a pledge which aims to help those worried about how rising interest rates will affect their mortgage repayments.

The Charter was approved by the Financial Conduct Authority (FCA) and signed by many of the UK’s largest mortgage lenders, including the likes of NatWest and HSBC.

“The agreement of a Mortgage Charter, following discussions between mortgage lenders, Government and regulators, will provide further reassurance to customers who may be anxious about their household finances,” said Alison Rose, CEO at NatWest.

One of the promises within the Charter is to allow struggling borrowers to switch to an interest-only repayment plan for up to six months, without it affecting their credit score.

But will this arrangement offer some reprieve for struggling homeowners, or will it cause further distress in the future?

Before this article goes any further, it is important to understand what the Charter means.

Under an interest-only mortgage, borrowers only need to make the monthly interest repayments with the larger borrowed capital due at the end of the term.

You can choose to take out an interest-only mortgage if you’re a first-time buyer or the term on your initial deal is coming to an end soon. These borrowers would then need to plan how they will repay the initial capital borrowed at the end of the mortgage term, generally through some form of investment plan.    

While the principle remains, these types of mortgages aren’t what the Mortgage Charter is referring to.

Before the Charter was introduced, some fixed deals allowed their borrowers to switch to an interest-only arrangement to lower their monthly repayments. Since it was for a temporary period, this doesn’t mean these borrowers will revert to a new mortgage or rate.

"Switching to interest only pauses the mortgage balance and means you will not see the balance reduce, you are just servicing the interest," explained Oliver Dack, a Spokesperson at Mortgage Advice Bureau (MAB). 

Under the Mortgage Charter, this arrangement remains, with the primary difference being that the temporary switch won’t appear on the borrower’s credit file. Dack said he main advantage of this difference is that is can help borrowers find the best deals to suit their needs. 

To illustrate how this switch could work, consider the example below, using Moneyfactscompare.co.uk calculations.  

Joe borrows £200,000 to purchase his home. On the average two year fixed rate for July of 6.39%, this works out to a monthly repayment of £1,336 a month on a capital and interest mortgage.

If he decides to switch to an interest-only mortgage for six months his new bill will fall to £1,065 for that period.

While it now means he has £271 extra a month to go towards other bills, he is no closer to owning his home after the six-month period. Once this expires he’ll need to decide how to pay off the outstanding balance of £1,626.

This can be done through a lump sum or increasing the monthly repayments on his mortgage.

Another measure agreed upon in the Mortgage Charter is for borrowers to extend their mortgage term.

This will lower their monthly repayments, but increase the total amount owed at the end of the mortgage term.

For example, Joe’s monthly mortgage repayment of £1,336 a month is based on a 25-year repayment plan. If he added a year onto his term, his monthly repayments would fall by about £20 a month.

However, the total interest due would be higher.

The Mortgage Charter also mentioned that those worried about how rising interest rates would impact their mortgage repayments can speak freely with their lenders without it affecting their credit score.

In addition to this, there is always the option of consulting an independent mortgage adviser to assess the options best suited to you.