An interest-only mortgage means that monthly payments made to the lender are solely for the purpose of paying interest on the loan, not ‘capital’ (the original sum borrowed, essentially). The capital amount outstanding therefore does not decrease at all. Therefore, the monthly payments are lower than those for a repayment mortgage. However, the borrower still has to repay the original amount borrowed at the end of the term regardless.

In 2014, the FCA’s Mortgage Conduct of Business (MCOB) rules relating to interest-only mortgages changed following the Mortgage Market Review. New rules were introduced following concerns that borrowers were being encouraged to take out a mortgage of more than they could afford to realistically pay back, and were able to arrange an interest-only mortgage without being required to make arrangements to fund the repayment.

An interest-only mortgage can only now be started if the lender has obtained evidence that the borrower has a credible way of repaying the capital amount. A credible repayment strategy would be, for instance, regular savings guaranteed to provide the borrower with the sum needed to repay the mortgage in full at the end of the term. Lenders must now also contact the borrower at least once during the term of the mortgage to ascertain whether there have been any changes, and that the repayment strategy remains in place – meaning that the borrower still has the potential to repay the capital. Popular methods of funding interest-only mortgages include endowments, ISAs and pensions.

Many lenders stopped offering interest-only mortgages to new borrowers in response to these changes. More recently, lenders have started offering interest-only mortgages once more.

When an interest-only mortgage is taken out, the two main issues to be addressed are: putting in place a funding mechanism or structure to repay the debt at the end of the term; and ensuring there is enough protection to enable the amount to be repaid should the borrower die before the end of the term.