Interest-only deals, which allow homeowners to repay only the interest and defer repaying the capital, appeal to those on a budget.

On a £100,000 mortgage with an interest rate of 5 per cent, repaying capital as well as paying interest would cost £591 a month. On an interest-only basis, the payments fall to £416, saving £2,100 over a year.

Interest-only mortgages were traditionally the preserve of endowment policyholders relying on the endowment to pay off the full loan on maturity. Now an increasing number of people are choosing the lower monthly cost without planning how they will repay the debt. The number of borrowers with interest-only deals who do not specify a repayment method when they apply for a loan has risen from 7.5 million in March 2004 to 12.4 million this year, figures from the Council of Mortgage Lenders show.

There is growing concern that this is a disaster waiting to happen. The state of the housing market means it is less likely that borrowers will be able to rely on double-digit house price growth to reduce the size of their debt in relation to the size of their equity stake.

With affordability ratios already stretched and interest rates expected to rise before the end of the year, most economists are predicting that house prices will remain subdued for the next few years.

In the past, borrowers with interest-only deals have also relied on inflation to eat away at the size of their mortgage. But since the Bank of England gained independence in 1997, inflation has averaged little more than 2 per cent a year. Experts say this cocktail of low house price growth and inflation could leave millions of interest-only borrowers facing a bleak financial future.

Nick Gardner, of Chase De Vere Mortgage Management, the broker, says: “It is incredible that so many people do not realise that they have to set up a repayment vehicle, and that if they do not, they will not own their home at the end of the mortgage term. This could lead to huge problems — borrowers may have to repay a 25-year mortgage in ten years, or extend the term until well into retirement.”

Interest-only payments are most often recommended to first-time buyers on low incomes to ease the burden in the first couple of years, but on the basis that they switch to capital repayment when their incomes increase. They are also considered suitable for anyone who wants to pay off a loan in big chunks.

But because borrowers are not required to have a repayment vehicle in place when they apply for a loan, experts fear that many who are not suited to interest-only deals are choosing the method and putting themselves in danger.

Mr Gardner says: “With the old endowment system, the repayment scheme had to be assigned to the lender so that the bank or building society could see it and monitor it. Now fewer lenders require the policies to be assigned so there is no way of knowing whether somebody has a repayment vehicle in place, or how much they are putting in. That is a big worry.”

Older second or third-time buyers, whose incomes are less likely to rise significantly, could be especially at risk. Mark Chilton, of Purely Mortgages, another broker, says: “These borrowers are typically already overstretched and their future earning potential is usually lower, making it less likely that they will ever be able to repay the capital.”

There are also worries that many homeowners on interest-only deals are delaying switching to capital repayment because of the “buy now, pay later” culture of debt acceptance, and that they harbour unrealistic expectations that they will be saved by a future windfall, such as an inheritance.

Mr Chilton says: “Many are relying on inheriting their parents’ property. This may be optimistic. Inheritance is being taxed more heavily and the parents of homebuyers may need to free up the equity in their property to help fund their own retirements.”

Anyone on an interest-only deal who is not making provision to pay off the loan should review his or her budget and consider switching to capital repayment. Jon Burridge, of Quantum Mortgages, the broker, says: “You should regularly review whether it is still the most appropriate way to fund your property purchase.”

Although lenders charge administration fees for switching to capital repayment, which can be as high as £199 with Cheltenham & Gloucester, anyone who does not have a repayment vehicle and can afford to switch should not be put off. James Cotton, of London & Country Mortgages, the broker, says: “It is worth paying the fee to switch if you are worried.”

In the long-term, interest-only deals are a false economy. Experts say that switching to capital repayment will save you a lot of money.

• For more on mortgages, go to www.timesonline.co.uk/mortgage

Explore Property

• Buying & Selling

• New Homes

• Overseas

• Interiors

• Investment

• Gardens

• Specials

Times recommends

• Fall in house sales hits builders, estate agents and mortgage brokers
• Why the property credit crunch favours cash buyers
• The blood-curdling history of Quarrelwood House