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In March of this year the Bank of England predicted that credit conditions would tighten over the course of the year, which means bad news for people with interest-only mortgages as they could struggle to keep up with their increased payments.

The news is also a set back for those struggling to get on the property ladder who would usually resort to interest-only mortgages for the first two years of the loan.

For borrowers it’s easy to be seduced by the 'borrow more, pay less' promise of interest-only mortgages. However, these deals are not as good as they look and often you can end up paying up to twice as more than you borrowed in the long-term.

With any mortgage, borrowers have to pay back the capital debt (the sum you actually borrowed) as well as interest on that debt in order for the lender to make a profit from lending you the money.

An interest-only mortgage means you only pay back the interest on the mortgage every month. This means that, on a typical £100,000 mortgage, you can cut your annual payments by around £2,000.

However, the problem is that the capital debt is still outstanding. In other words, you haven't actually paid back any of the amount you originally borrowed. Whereas, with a repayment mortgage, you spread the repayment of the capital debt and the interest into even monthly payments over the course of the mortgage term.

So, if you take out a 25-year mortgage, at the end of those 25 years, your mortgage is guaranteed to be paid off.

While with an interest-only mortgage you've 'cut' your annual payments by around £50,000 over the course of those 25 years at the end of the term, unlike a repayment mortgage, you will suddenly have to pay the lender a £100,000 lump sum.

The reason an interest-only mortgage works out more expensive over the long-term is because, if you do not pay back any of the £100,000 capital debt, the lender will charge you interest on the entire loan for the entire term.

By contrast, with a repayment mortgage, you are trying to get rid of your debt from day one and gradually chip away at it on a monthly basis until it's all gone.

If you're stretched financially, desperate to get on or move up the property ladder and confident your income will soon go up, then an interest-only mortgage may not be such a bad idea. That's as long as you understand the extra costs involved.

But the moment you can afford to meet the higher monthly payments on a repayment mortgage you should consider switching your type of mortgage and/or lender.   

Most people will rely on an increase in the price of a property to pay off the capital debt at the end of the mortgage term. However, the credit crunch has reminded us that this is not something that can be guaranteed, or even relatively achieved in the near future.

More than one in four mortgages taken out in 2006 were interest-only, double the number taken out in 2002 as the number of first-time buyers taking out repayment mortgages fell from 88 per cent in 2002 to 67 per cent in 2006.

It is vital now that the borrowers who went interest-only to help their affordability in 2006 or 2007 revert back to capital repayment, or overpay accordingly, as interest rates have started to reduce.

The author of this mortgage article is Mel Varley.

This article does not represent ‘financial advice’ as each persons individual requirements will be unique to their needs. If there is something in the article which you which to rely on then please check those details with any person with whom you arrange a financial product or service.

The views in this article represent those of the author and not those of Netbasic Limited.