A way to buy a better house - now

Over the past few years, demand for interest-only mortgages has fallen, with buyers opting instead for a home loan on a repayment basis. Mis-selling of endowment policies and resultant endowment shortfalls have given rise to the view that an interest and capital repayment mortgage is the safer bet.

Over the past few years, demand for interest-only mortgages has fallen, with buyers opting instead for a home loan on a repayment basis. Mis-selling of endowment policies and resultant endowment shortfalls have given rise to the view that an interest and capital repayment mortgage is the safer bet.

But interest-only mortgages could be experiencing an upsurge in popularity, driven in part by higher house prices. Although banks and building societies will not generally lend more to buyers who take out an interest-only loan, buyers might feel that they can stretch themselves further by opting just to pay interest, and deferring repayment of the loan itself, as this leads to lower monthly payments.

A survey of first-time buyers, by Bradford & Bingley, found 24 per cent of borrowers take out either an interest-only mortgage or one that combines an interest-only and a repayment element. But almost three-quarters of those taking out an interest-only or combined mortgage did not arrange a repayment vehicle, when they took out the loan.

In most cases, lenders will not ask how the mortgage will be paid off, leaving the buyer to organise that. Endowment policies now act as a repayment vehicle for only a small percentage of mortgages, but homebuyers can make use of PEPs or an investment Isa, the lump sum from a pension or funds saved as cash.

Even lenders with a reputation for rigid rules on repayment will generally accept sale of the property as a legitimate way to repay the home loan.

According to Ray Boulger, senior technical manager at mortgage broker Charcol, some homebuyers turn to alternative methods to finance paying off their loans. Using bonuses or money from commission is one way to pay off capital from a mortgage, but one of the more eccentric methods chosen by Charcol involved a homebuyer selling a classic car, in order to pay back the mortgage capital.

Boulger recommends that homebuyers eligible to join workplace share schemes could look at this as one way to pay off a mortgage. Buyers might feel that they would not be able to find enough spare money each month to pay into a Sharesave scheme, but by diverting money from capital payments, this might well be possible. At the least, Sharesave schemes attract high interest rates. At best, members might be able to sell the shares for a handsome profit.

A further, but risky, option is to rely on an inheritance to pay off mortgage capital. In some cases, it can be possible to arrange an interest-only mortgage without any clear plan at all for how to pay off the loan.

In cases where a homebuyer is confident that their income will rise, an interest-only mortgage might be one way to afford a better house now, by keeping monthly payments as low as possible. The buyer can switch to making capital and interest payments once their income has risen,

"For graduates, who might see their salary rise significantly in two to three years' time, it is an option," says Boulger. An interest-only mortgage might be one way for a graduate to step onto the property ladder while paying off other debts.

Even where a borrower does not have a formal mortgage repayment mechanism in place, it is good to have an overall strategy. A buyer could take out a flexible mortgage on an interest-only basis, in order to keep payments low. They could then make capital repayments into the account whenever money was to hand. Managed carefully, this could even pay off the mortgage more quickly than a conventional home loan, but it is only suitable for homebuyers who will pay close attention to their mortgage arrangements.

Louise Cuming, head of mortgages at MoneySupermarket, the online service, has noticed higher demand for interest-only loans recently, with many buyers arranging these as a flexible mortgage. "The contracted part is interest-only but you can make capital payments, perhaps three or four times a year," she says.