Wealthy UK borrowers face interest-only mortgage payment shock

Wealthy borrowers in the UK with large interest-only mortgages face a punishing jump in payments — leaving them potentially paying thousands of pounds a month more — as they come off fixed-rate deals in a rising interest rate environment.

The focus of what MPs have dubbed the country’s “mortgage time bomb” has understandably been trained on households already hit hard by the cost of living crisis, particularly on younger families who tend to have bigger outstanding loans.

But repayments on interest-only mortgages, which tend to be favoured by relatively affluent borrowers, are also forecast to increase by thousands of pounds each month as the sensitivity of the products to rate movements leads to much bigger swings in monthly costs than a capital repayment deal.

The Bank of England decided to raise interest rates a half-point last month to 5 per cent, its 13th consecutive rise. It is predicted to lift rates to 6 per cent next year in an attempt to bring down stubbornly high inflation.

“When mortgage rates were cheap, we’d have clients saying ‘lend me as much as you can for as long as possible’,” said Carlos Mendes, a banker at Investec, a private bank whose 7,000 clients have an average income of £700,000 and a personal net asset value of £11mn.

Interest-only mortgages are popular with wealthy borrowers such as bankers and private equity executives, who receive part of their pay in annual bonuses or shares. This is because the products keep monthly payments low and allow borrowers to stretch themselves more, as the payments reduce the interest and not the capital sum.

But BoE data shows that by the end of 2026, about 215,000 mortgage borrowers will see their payments rocket by £1,000 or more per month — 56,000 of these are interest-only mortgages and 60,000 are a mix of capital repayment and interest-only, according to the central bank.

For instance, in July 2020, a two-year interest-only mortgage of 1.69 per cent was available from HSBC, meaning a borrower with a £300,000 mortgage and a 25 per cent deposit would have paid £5,070 a year. 

In July 2023, HSBC offered a similar deal for remortgaging at 5.79 per cent. Ignoring one-off fees, that equates to £17,370 a year for the same borrower. Monthly costs would jump from £423 to £1,448, more than three times as much. 

Investec’s Mendes said that, faced with upcoming payment shocks, clients were now using annual bonuses or property sales to pay off part of their loans and soften any payment shock.

One senior banker with a £1.14mn interest-only mortgage says he expects his payments to go up from £1,200 a month to £7,000 later this year and so plans to pay down part of the capital instead.

In the wake of rising rates, clients have begun to change their behaviour.

“I had one client who was building his own house and had all the planning permissions and was ready to go but had to pull out of this when rates went to nearly 6 per cent,” said Dean Esnard, director of Magni Finance, a mortgage broker specialising in home loans above £500,000.

UK banks do not publicly break down how many of their customers are on interest-only mortgages. There were 702,000 outstanding pure interest-only mortgages at the end of 2022, according to UK Finance. In the first quarter of 2023, 8 per cent of newly advanced residential mortgages were interest-only, compared with 87 per cent on interest and capital repayment terms, according to BoE data. 

The proportion of interest-only mortgages has declined since the financial crisis because of tighter lending regulations, which introduced stringent affordability tests. In the first quarter of 2008, pure interest-only accounted for just under 44 per cent of new residential mortgages — now it is 11.5 per cent of all mortgages. 

Adding in “part-part” mortgages, which combines a portion of interest-only with a repayment loan, brings the share of mortgages with an interest-only element to just under 16 per cent. 

Banks say that since 2008, interest-only mortgages tend to be limited to more prosperous clients. The interest-only jumbo mortgages over £1mn are usually offered by private banks that cater for the affluent, such as Coutts, which is owned by NatWest.

Interest-only deals also apply stricter criteria on eligibility than repayment mortgages. Lenders may demand a minimum income level, limit term length to 25 years and insist the mortgage ends before retirement and that borrowers must have a plan for repayment of the capital sum. 

If they plan to pay it off by selling the home, lenders typically set lower limits on the loan size as a share of the property’s value. 

“All of these things naturally skew interest-only towards higher net worth borrowers,” said David Hollingworth, director at L&C Mortgages, a broker.

In the recent era of low interest rates, it has often made sense for prosperous borrowers to borrow cheaply and then deploy their wealth elsewhere to get returns from shares or bond portfolios that outstrip the cost of borrowing.

“It’s about being clever and sophisticated with their personal balance sheets,” said Michelle White, co-head of the private office at Investec Wealth.

“Some people prefer to reduce their monthly payments and so go for interest-only rates and instead invest their money in property or the stock market,” said Aaron Strutt, product and communications director at mortgage broker Trinity Financial Group.

Esnard of Magni Finance says that interest-only mortgages can help well-off professionals who may receive annual bonuses but need lower monthly payments.

In the past 18 months, more banks and building societies, backed by regulators and the government in its “mortgage charter”, have suggested mainstream borrowers struggling to pay soaring mortgage bills should consider a temporary switch of six months to interest-only mortgages — or an extension of the term of their loan — for short-term financial relief. 

Brokers said this might lead to a short-term increase in interest-only borrowers but cautioned a permanent rise was unlikely because of tighter eligibility criteria applied to interest-only loans, which would kick in after the initial six months. 

Switching to interest-only does cut monthly payments substantially. On a £200,000 mortgage at an interest rate of 5.5 per cent over 25 years, the monthly bill under an interest and capital repayment mortgage would be £1,228. On an interest-only deal, that would fall to £917 a month, according to broker L&C Mortgages. However, on a repayment mortgage over 25 years, the borrower would pay £169,000 in interest, compared with £275,000 on an interest-only arrangement. 

Bankers dealing with high net worth customers say many are well prepared for the upcoming payment shock. “We are not seeing a scenario with lots of clients contacting us in distress,” said Investec’s Mendes.

Esnard added: “It’s no time to panic.”