With a normal interest-only mortgage, borrowers repay the interest on their loan each month.
At the end of the mortgage term they then repay the capital they borrowed. So for example, if you took out a £200,000 loan over a 25-year term, at the end of the 25 years you’ll have to pay back £200,000 - the monthly repayments just cover the interest you are being charged on that figure.
A retirement interest-only mortgage (RIO) is rather similar in that there is a monthly payment to cover the interest on the amount you’ve borrowed.
However, usually the actual mortgage amount that you borrow is only paid back, through the sale of the property, when you hit a certain ‘life event’, whether that’s moving into full-time care or passing away.
Some RIO mortgages allow you to pay off some of the capital you’ve borrowed too. By doing so you can ensure that when you pass away or move into care more of the value of the property will go to your loved ones, rather than to the mortgage lender.
Why might somebody want to take out a RIO mortgage?
There are a host of potential borrowers who might be attracted by the idea of an RIO mortgage.
Some older people might want to purchase a new property that is more suitable for their needs in later life, but don’t have sufficient funds with which to do so through selling their existing property.
Alternatively, a borrower might be looking to release some of the equity they have built up in their existing property, whether to top up their pension funds, or to gift to a loved one, perhaps to help a grandchild get onto the housing ladder.
One selling point for RIO mortgages is that it may be easier to pass the affordability tests compared to going for a traditional mortgage, as the monthly repayments will be much smaller.
RIO mortgages are also a popular option for older borrowers who are already on an interest-only mortgage which is nearing its conclusion, and who do not have any means for repaying the capital they borrowed beyond selling the property.
How is a RIO mortgage different from an equity release mortgage?
A RIO mortgage is not hugely dissimilar from an equity release deal, in that both are designed to help you tap into the value of the equity that you have built up in your property. There are however some very important differences.
With an equity release product, you borrow a portion of the value of the property, but importantly there are no monthly repayments to worry about.
Instead, the debt grows over time, and is eventually repaid when you pass away or the property is sold as you move into long-term care.
With equity release deals, lenders have committed to offering no negative equity guarantees. This ensures that the loan you eventually have to pay off will never be higher than the value of the property when the time comes to sell up, meaning your loved ones will never have to use their own money in order to clear the loan.
However, it is very possible that as the interest charges build up, there is little or nothing left once the loan is repaid, meaning you do not get to leave much of an inheritance.
This is unlikely to happen with a RIO mortgage, unless there is a dramatic fall in the value of the property, as the money you owe will not increase over time.
The possible downsides to a RIO mortgage
Before you rush off to apply for a RIO mortgage, it’s important to bear in mind some of the possible negatives.
For example, you may be more limited in how much you can borrow compared to a traditional mortgage - lenders may only be willing to offer up to 50% of the value of your property on an interest-only basis, whereas they may go up to 65% on a traditional repayment deal.
It’s worth remembering that lenders in this area of the market all have different lending criteria - while some will lend to you at 60, others won’t offer a RIO deal until you hit 65, for example.
Similarly, they will all have different rules on the minimum loan size and minimum value of your property, and look for different proof of income from would-be RIO borrowers.
While an affordability test will be easier to pass with a RIO mortgage, as a result of the reduced repayments, you will still need to show that the loan is affordable before you’ll be able to take one out.
In addition, you will need to be able to keep up with those monthly repayments if you want to avoid the threat of repossession.