Interest only mortgage vs repayment: Which is best?

Written by: Sean Horton CeMAP

When it comes to choosing a mortgage repayment method, there are a few different options available to borrowers.

Two of the most popular types of mortgages are interest-only and repayment. Both have their own set of advantages and disadvantages, and it’s important to understand the differences between them.

In this guide, we will take a closer look at the differences between interest-only and repayment mortgages, including the pros and cons of each option. We will also discuss the factors that borrowers should consider when making a decision about which type of mortgage is right for them.

Whether you’re a first-time homebuyer or an experienced property investor, this guide will provide you with the information you need to make an informed decision about which one is right for you.

Interest only mortgage vs repayment: Which is best?

How does an interest only mortgage work?

An interest-only mortgage is a type of loan where you pay only the interest on the mortgage each month.

Interest only mortgage bar chart

Your monthly payments will be much lower than they would be with a traditional repayment mortgage because you will be only paying the interest on the loan and not the capital amount. This will make an interest-only mortgage more affordable for you and allow you to borrow more money or have more disposable income each month.

However, it’s important to remember that with an interest-only mortgage, you will not be paying back the mortgage, and you will need to have a plan in place to pay off the remaining balance at the end of the interest-only period. This plan could be through savings, investments, or the proceeds from selling the property.

How does a repayment mortgage work?

repayment mortgage, also known as a capital repayment mortgage, is a type of loan where you make regular payments that include both interest and a portion of the capital amount borrowed. Over time, these payments gradually reduce the amount you owe, and by the end of the loan term, usually 25 years, the loan is fully paid off.

Repayment mortgage chart

During the loan term, your monthly payments will be higher than they would be with an interest-only mortgage because you are paying off the capital as well as the interest. However, the overall cost of the mortgage will be lower in the long run.

With a repayment mortgage, you have the security of knowing that the loan will be paid off in full at the end of the term and you don’t have to worry about coming up with a plan to pay off the remaining balance at the end.

What are the advantages of an interest only mortgage?

The advantages of an interest-only mortgage include:

Lower monthly payments: One of the main advantages of an interest-only mortgage is that the monthly payments are considerably lower than they would be with a repayment mortgage. 

Flexibility: Another advantage of an interest-only mortgage is that you have more flexibility in terms of how you pay off the loan. You only need to pay the interest during the mortgage term, after which you can then decide whether to sell the property, pay off the remaining balance in one lump sum or refinance the mortgage.

Good for short-term: If you’re planning to sell the property within the interest-only period, an interest-only mortgage can be a good option because you can save on monthly payments and use those funds for other investments.

What are the advantages of a repayment mortgage?

A repayment mortgage has several advantages, some of these include:

Gradual repayment of the loan over time: With a repayment mortgage, you will be paying back the loan in full over the course of the loan term. This means that you will gradually pay off the loan, which can be more desirable for most people.

More security: With a repayment mortgage, you have the security of knowing that the loan will be paid off in full at the end of the term, which can provide peace of mind.

Good for long-term: Repayment mortgages can be a good option if you’re planning to stay in the property for the long-term. You can have the security of owning the property with no need of planning for the remaining balance.

Additionally, repayment mortgages can help you build additional equity in your property over time, which can be beneficial when looking to sell or refinance in the future.

You may want to consider: How to change an interest only mortgage to repayment.

What are the benefits and drawbacks of each one?

The main advantage of an interest-only mortgage is the reduction in monthly payments as the borrower pays only the interest and nothing towards the principal amount.

This can be beneficial for those who have a strategy in place to pay off the debt in the future, such as using proceeds from downsizing in retirement or rental income from a buy-to-let investment. However, it is important to keep in mind that in addition to the mortgage, a repayment plan must also be set in place, whether it be through savings or investments.

On the other hand, capital repayment mortgages have higher monthly payments but the mortgage amount is gradually paid off over time, which ultimately reduces the overall cost of the mortgage. It is a much simpler arrangement as the lender works out how much you need to pay to fully repay the debt.

Will all lenders offer interest only?

The availability of interest-only mortgages can vary among lenders and depend on the lender’s risk appetite and the current market conditions.

Some lenders may have stricter criteria for borrowers who apply for an interest-only mortgage, such as higher credit scores, lower loan to value, and higher income requirements. Additionally, some lenders may require that borrowers have a solid plan in place for how they will pay off the remaining balance at the end of the interest-only period.

Our article Can you change your mortgage to interest only? provides some further information and tips.

In recent years, the availability of interest-only mortgages has decreased, as lenders have become more cautious about the risks associated with these types of loans. Lenders have been affected by the mortgage market crisis, and the Financial Conduct Authority (FCA) has introduced stricter rules for mortgage lending. This means that lenders are now more likely to prefer capital repayment mortgages over interest-only mortgages.

In order to have a better chance of getting approved for an interest-only mortgage, it is better to consult a professional mortgage broker that can guide you to the right lender that offers this type of mortgage.

When is it better to have an interest-only mortgage over capital repayment?

While an interest-only mortgage can have a higher overall cost, there are certain situations where it may be the more advantageous option for you:

  • For buy-to-let investments, where you want to keep monthly expenses low and maximise monthly yield.
  • If you plan to downsize during retirement and use the proceeds to pay off the mortgage.
  • As a retirement interest-only mortgage, where the loan is paid off upon death and the property is sold, rather than on a specific end date.
  • If you have an upcoming lump sum, such as from a property sale or inheritance, that can be used as a secure repayment plan.
  • If your current income is low but you anticipate it will increase in the future. An interest-only mortgage allows you to borrow more, with a plan to switch to a repayment mortgage when your income increases.
  • As a short-term solution during property restoration or renovation or when starting a new business.

Can you have a repayment and interest only mortgage?

Yes, it is possible to have a repayment and interest-only mortgage together. This type of mortgage is known as a “part-and-part mortgage,” which is a combination of both repayment and interest-only mortgages.

Part and part mortgage

With a part-and-part mortgage, you can have the benefit of lower monthly payments, as with an interest-only mortgage, but also have the security of gradually reducing some of the capital loan amount over time, as with a repayment mortgage.

You can choose to split the mortgage in any proportion that you want, however, it is common to split it around 50/50. For example, you may choose to pay interest-only on 50% of the mortgage, and make capital repayment on the remaining 50%.

At the end of the term you will still need a way of repaying the interest-only element.

Can you change the mortgage type later on?

It is possible to change the mortgage type later on, but it will be dependent on the lender and your current financial situation.

Can you get an interest-only mortgage with bad credit?

It is possible to obtain a mortgage even if you have bad credit. Many people mistakenly believe that having a poor credit history disqualifies them from getting a mortgage. However, many lenders are aware that credit problems can happen to anyone and tend to have a more comprehensive and understanding view of your financial situation.

To increase your chances of being approved, it’s essential to have a clear understanding of your credit status.

Get an up-to-date copy of your credit file, check it thoroughly, and consider any steps that you can take before applying to improve it. Working with a specialist mortgage broker who deals with bad credit mortgages can be helpful as they can direct you to the lenders who are more likely to approve your application.

So which one is best?

The 3 different types of repayment method each have their own pros and cons. The ‘best’ one will be the solution that suits the mortgage borrower the most.

For the majority of people borrowing money to buy or remortgage their home, a full repayment mortgage would be the preferred choice. This ensures the debt is being repaid in a structured way, with no nasty surprises at the end.

Interest only mortgages do have their uses, as long as you are aware of the downsides. Most buy to let mortgages are setup as interest-only. There’s no difference in interest rate but you may find that there are less lenders to choose from.

And the part and part option sits in the middle, perhaps offering the best of both?

For any type of mortgage it is important to review it from time to time to make sure it is still suitable for your needs.

How a mortgage broker can help

Deciding between an interest-only and a capital repayment mortgage can be difficult, particularly with options that blend both, such as mortgages with initial interest-only periods or part-and-part mortgages.

This is where a professional mortgage broker comes in handy. They can evaluate your individual circumstances and assist you in determining which type of mortgage will suit you best.

Once you have made your decision, your mortgage broker can use their extensive market knowledge to find lenders that offer the most competitive rates. They can also negotiate on your behalf, which can save you both time and money.

Sean Horton is a co-owner of Drake Mortgages and has worked in financial services, mortgages and insurance since 1988. He regularly writes about mortgages, bridging loans and commercial finance.
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