What Is a Lifetime Interest-Only Mortgage and How Does It Work?

A lifetime interest-only mortgage is designed for older borrowers who want to maintain homeownership while keeping monthly payments low. Instead of paying down the principal, borrowers cover only the interest, making it an attractive option for those on fixed incomes or looking to free up cash.

This type of mortgage has specific eligibility requirements and repayment conditions that differ from traditional loans. Understanding how it works, what lenders look for, and its impact on taxes and estates is essential before considering one.

Payment Structure

Monthly payments cover only the interest, leaving the loan balance unchanged. The interest rate may be fixed or variable. Fixed rates provide predictable payments, while variable rates fluctuate based on market conditions. For example, a $200,000 loan at a 5% fixed rate results in a monthly payment of $833.33 indefinitely, assuming no rate changes or additional fees.

Lenders typically require monthly payments, though some offer quarterly or annual options. Late payment penalties may include additional interest charges or fees. Some lenders allow overpayments, enabling borrowers to reduce future interest costs, though this is optional.

Variable-rate loans are often tied to benchmarks such as the Bank of England base rate or the Secured Overnight Financing Rate (SOFR) in the U.S. If a borrower starts with a 4% rate and the benchmark increases by 1%, their new rate would be 5%, leading to higher monthly payments.

Lender Requirements

Lenders impose eligibility criteria to manage risk. Most require borrowers to be at least 55 or 60 years old, with some setting upper age limits around 85.

Income assessments focus on the borrower’s ability to cover interest payments. Pension income, annuities, Social Security, and investment returns are considered, with lenders applying affordability tests to ensure long-term sustainability. Debt-to-income (DTI) ratios may be reviewed, but cash flow stability is the primary concern.

Property valuation is another key factor. Lenders require a professional appraisal to confirm the home meets minimum value standards, typically around £100,000 in the UK or $150,000 in the U.S. Certain properties, such as leasehold flats with short remaining terms or homes in poor condition, may be ineligible. Loan-to-value (LTV) ratios are usually capped at 50-60% of the home’s appraised value to protect against declining equity.

Credit history is considered, though underwriting is generally more flexible than for conventional mortgages. While a perfect credit score isn’t necessary, lenders examine payment history, existing debts, and any history of bankruptcy or foreclosure. Some lenders reject applicants with recent credit issues, while others approve loans with higher interest rates or stricter conditions.

Principal Repayment Methods

Since the loan balance remains unchanged, repayment is typically deferred until the borrower moves into long-term care or passes away. The home is then sold to settle the loan, with any remaining equity going to the estate or designated beneficiaries. Market fluctuations can impact the home’s value and inheritance.

Some borrowers choose to repay the principal voluntarily through lump-sum payments or structured overpayment plans if permitted. This reduces total interest costs, but many lenders impose early repayment charges (ERCs), often calculated as a percentage of the balance or a set number of months’ interest. Borrowers should review loan terms before making additional payments.

Refinancing allows borrowers to switch to a standard repayment mortgage or another interest-only product. This may be viable for those with improved finances or those looking to extend the loan term. However, refinancing depends on factors such as age, income, and prevailing interest rates. If rates have risen significantly, a new loan could lead to higher monthly costs. Lenders may also reassess affordability, which can be challenging for retirees on fixed incomes.

Tax Treatment

Interest payments may be tax-deductible in certain cases, depending on how the loan proceeds are used. In the U.S., mortgage interest is generally deductible if the loan qualifies as home acquisition debt or home equity debt under IRS rules. If funds are used for home improvements, deductions may apply, but if used for general expenses or investments, deductibility may be limited. The Tax Cuts and Jobs Act (TCJA) of 2017 capped deductible mortgage debt at $750,000 for loans originated after December 15, 2017. Borrowers should consult IRS Publication 936 or a tax professional for guidance.

For those using loan proceeds for investments, such as stocks or rental properties, interest payments may be deductible as investment interest expense. However, this deduction is limited to net investment income and requires filing Form 4952. Any disallowed interest may be carried forward to future years. Keeping detailed records of loan use is essential for compliance and potential audits.

Estate Considerations

A lifetime interest-only mortgage affects estate planning, particularly the inheritance left to beneficiaries. Since the loan balance remains unchanged, the amount owed at repayment can significantly reduce the estate’s value. If property values rise, heirs may still inherit some equity after the home is sold. However, if values stagnate or decline, little to no equity may remain. Some lenders offer a no-negative-equity guarantee, ensuring the debt never exceeds the property’s sale value, which can provide reassurance to borrowers and their heirs.

Estate taxes may also be impacted. In the U.S., the federal estate tax exemption for 2024 is $13.61 million per individual, meaning most estates won’t owe federal taxes. However, some states impose their own estate or inheritance taxes with lower exemption thresholds. The outstanding mortgage balance is typically deducted from the estate’s total value when calculating tax liability, potentially reducing the taxable portion.

Beneficiaries who wish to keep the property rather than sell it must arrange alternative financing to settle the loan, which could involve refinancing or using other estate assets. Proper estate planning, including trusts or gifting strategies, may help minimize tax burdens and ensure a smoother asset transition to heirs.