Interest-only Mortgages
With an interest-only mortgage, your repayments each month only cover the interest charged on the whole loan amount. This means that the mortgage loan itself does not reduce. They have lower monthly payments compared to repayment mortgages, which is their main advantage.
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- What is an interest-only Mortgage?
- Who might be suited to an interest-only mortgage?
- Try our interest only mortgage calculator
- Differences between interest-only and repayment mortgages
- What happens at the end of an interest-only mortgage term?
- Interest-only mortgage rates
- Interest-only mortgage lenders
- Interest-only mortgages FAQs
If an interest-only mortgage is something you are looking into, we can help.
- We have access to the whole market, so we can find the right lender for you.
- We can make enquiries on your behalf and get you the best deal possible.
- We can set you on the path to owning your home.
What is an interest-only mortgage?
An interest-only mortgage differs from a repayment mortgage in a very significant way. With a repayment mortgage, your monthly instalments go towards paying the mortgage amount as well as the interest. Over time, the mortgage payment and interest both decrease over the set period of time until the loan is repaid. This is sometimes referred to as a ‘capital and interest’ mortgage, to differentiate it from an ‘interest-only’ mortgage.
With interest-only, your repayments each month only cover the interest charged on the whole loan amount, so the loan itself does not reduce. The main advantage of interest-only mortgage is that the monthly payments are less than those for a conventional mortgage. However, as the loan isn’t being paid off you will need to pay money into another fund. This is to ensure you will be able to pay the loan off when your mortgage comes to term, if not before.
Who might be suited to an interest-only mortgage?
An interest-only mortgage is helpful for individuals with specific borrowing needs. We have seen many different borrowers, including first-time buyers, investors, and people moving homes, benefit from this model.
In expensive areas, an interest-only mortgage is a convenient way to buy a property and help reduce cost. This is because in many instances, the monthly payments will be cheaper than renting a property. You will also own your home, albeit with a mortgage on it.
Buy-to-Let investors who purchase properties for rental purposes often opt for this type of mortgage. This choice allows them to maintain lower monthly expenses. This can assist at times of possible rental voids.
Interest-only mortgages can also present the same attractive low monthly commitments to people whose income may fluctuate. This includes people such as contractors, freelancers and the self-employed. They can pay off parts of the mortgage throughout the term and reduce the total amount.
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Differences between interest-only and repayment mortgages
An interest-only mortgage differs from a repayment mortgage in a very significant way. With this type of mortgage, you just pay off the interest. This will result in significantly lower monthly payments to the lender. But, because the loan amount itself is not decreasing it means that you will be charged more interest over the loan period than if you had been paying off the mortgage each month.
With a repayment mortgage, monthly instalments go towards paying off your mortgage amount as well as covering the interest. This means that both the mortgage and interest decrease over the planned period of time until the loan is repaid. This is sometimes referred to as a ‘capital and interest’ mortgage, to differentiate it from an ‘interest-only’ mortgage.
It’s best to show how interest-only and repayment mortgages might compare with some examples.
At any point in time, there will be a huge variety of mortgage products and interest-only mortgage rates available.
For the sake of simplicity, we will look at scenarios with representative interest rates of 3%, 4% and 5%.
We’ll base our examples on a purchase price of £232,000, with the buyers putting down a 25% deposit and obtaining a mortgage of £174,000 over a term of 25 years.
Please note: this illustration should not be considered as mortgage advice. Actual figures in your case may differ according to several influencing factors. Always talk to a specialist mortgage advisor to get an accurate comparison.
| Interest-only | Repayment | |
| 3% Interest Rate | ||
| Amount Borrowed | £174,000 | £174,000 |
| Monthly Repayment | £435 | £825 |
| Total Repayable over 25 years | £304,500 | £247,538 |
| Interest Paid | £130,500 | £73,538 |
| 4% Interest Rate | ||
| Amount Borrowed | £174,000 | £174,000 |
| Monthly Repayment | £580 | £918 |
| Total Repayable over the term | £348,000 | £275,531 |
| Interest Paid | £174,000 | £101,531 |
| 5% Interest Rate | ||
| Amount Borrowed | £174,000 | £174,000 |
| Monthly Repayment | £725 | £1,017 |
| Total Repayable over the term | £391,500 | £305,156 |
| Interest Paid | £217,500 | £131,156 |
It’s important to note these calculations have very much simplified the process. They do not account for:
- Interest rate fluctuations
- Home insurance
- Redundancy insurance
- Nor payments to (and interest from) a repayment vehicle
A ‘part-and-part’ mortgage is a way of combining the two methods of payment. With a ‘part and part’ mortgage you pay towards a portion of the loan amount on top of interest payments. You would also arrange a payment vehicle to pay into, to cover the balance of the mortgage when it reaches the end of term.
For example, if you take out a mortgage of £160,000 you could have a repayment vehicle covering £100,000. This would be on an interest-only basis. The balance of £60,000 would then be paid off as per a repayment mortgage as part of your monthly payments.
The lender will calculate monthly payments to pay off £60,000 of the mortgage and cover the interest on the remaining amount. At the end of the mortgage period, the loan amount will have reduced from £160,000 to £100,000 and you would pay off this balance using the repayment vehicle.
This provides a convenient compromise between a solely interest-only mortgage or an entirely repayment home loan:
- Your monthly payments will be less than the equivalent standard repayment plan.
- You will need less in your repayment vehicle.
- And, because the loan amount reduces during the term of the loan, you will pay less interest than on a fully interest-only arrangement.
Can I remortgage an interest-only mortgage?
Yes, it is possible for you to get a remortgage on your property if you are currently in an interest-only deal. However, as these types of mortgages are considered a higher risk by the regulator. There are some strict criteria that you will need to adhere to in order to succeed.
Lenders normally only consider an interest-only remortgage under these circumstances:
- The borrower can show a higher level of income,
- The loan-to-value on the mortgage is maximum 75%,
- There is a significant amount of equity in the property,
- The property value is above their stipulated minimum.
To know for sure if you will be able to qualify for an interest-only remortgage, please contact our expert team of advisors. We will be able to give you reliable, independent financial advice on all your options.
What happens at the end of an Interest-Only mortgage term?
Unless you have made any capital contributions to reduce it, the mortgage sum will have remained the same. This sum will need to be paid off in full when the mortgage reaches the end of term.
Usually, money from the ‘repayment vehicle’ will be used to do so. If the repayment vehicle has not returned sufficient funds to do so, then you may have to sell the property to meet that debt.
Interest-only mortgage rates
You will be pleased to know that within the market there is no separate set of rates for interest-only mortgages. You can expect the same kind of rates as those for standard residential mortgages. And obviously, residential mortgage rates vary significantly from one product to another, depending on many factors. Some of these factors could be:
- Introductory period
- Level of deposit
- LTV ratio
Therefore, it makes it hard for us to offer a precise guide or bracket for what interest rates to expect. If you want to find out more about your options, get in touch today.
Interest-only mortgage lenders
Lenders will each have their own criteria for what they are willing to accept as repayment vehicles. They may reject those that they think will not give the borrower enough return on their deposits one example being cash in a standard savings account, as it may not give enough security on the full home loan.
At a minimum, you must have a plan to repay the mortgage. You’ll also likely need a good-sized deposit or amount of equity. Between 25%-50% is typical.
Some specialist lenders are not found on the high street or online ads. They typically collaborate with trusted third parties, like mortgage brokers. These brokers vet potential clients to ensure they are suitable for the lender’s business.
Overall, we have access to over 12,000 products through 90+ lenders. We know there will be a probable match for your needs out there. Get in touch with our team to arrange a free, no-obligation initial consultation.
If you’re looking for an interest-only mortgage, then it’s likely that you will be facing an uphill struggle to find enough insights on lenders and products to make an informed decision. Lenders are cautious, so there is limited public information and few service options available.
A lot of lenders offering these mortgages only work through trusted intermediaries. Often the best deals can be found through specialist mortgage brokers.
Our team at The Mortgage Centres includes specialists that are ready to help you. They have decades of experience in interest-only mortgages and an in-depth understanding of the UK mortgage market.
We have close working relationships with a broad spectrum of lenders, Ranging from those on the high-street to niche-market specialist companies, meaning we are able to access the best rates for interest-only mortgages.
If you would like to talk to someone about the benefits of an interest-only mortgage, contact our team today.
Interest-Only mortgages FAQs
If you’re in an interest-only mortgage agreement, it’s likely that the lender would have ensured you are accruing sufficient funds in a repayment vehicle.
However, in some cases the repayment strategy would have been the sale of the property, and if it has increased in value over the period of the mortgage then you will be able to sell it to pay off the loan, and possibly use the profit as a down payment on your next property, or to buy a lower-value property outright.
If you are looking to take out a new interest-only mortgage, then you will face more resistance. This is because most lenders won’t accept the sale of the property as a valid repayment plan. You will likely be required to show you have an alternative payment plan in place to meet the mortgage amount.
Although some lenders might consider it if certain aspects meet their criteria, such as a low loan-to-value ratio.
Yes, this is because lenders must make sure borrowers can afford monthly mortgage payments. So, by having a plan to pay off the full mortgage balance helps make this clear to a lender.
You will need to provide verification that you have done so to the lender when you apply for the mortgage. It’s also likely that lenders will make checks on the status of your repayment vehicle during mortgage term. This is to make sure that it’s on track and their loan is secure.
If you already have an interest-only agreement, you may not have needed to verify it beforehand. This is because the rules used to be less strict. Check if your repayment plan is on track. If you’re worried it won’t cover the mortgage, talk to your lender about what you can do.
Yes, and most lenders will permit borrowers to switch to a repayment mortgage during the term on an interest-only mortgage. You can try to do this by refinancing with your current lender. Alternatively, you can try finding a new lender.
However, this option is only possible if your current mortgage terms allow it. You may also want to consider switching to a ‘part-and-part’ mortgage. This is where a portion of the mortgage amount remains interest-only while the remainder is paid off on a repayment basis.
Changing your mortgage in this way is useful for people who can see that their repayment vehicle will not deliver the return expected by the end of term. It’s worth monitoring your fund’s performance regularly to make sure that the finances around your home are on track.
An experienced broker can help you navigate through the necessary steps and make sure you get the best deal possible.
Phil Scott
Director
About the author
Phil has worked in the financial services industry since 1992, having started with a large insurance company. He went self employed in 1996 as an Independent Financial Adviser before setting up his first company, Needham Market Home Financial in 1999.
After four years, he decided to concentrate solely on mortgages and related insurances, and The Mortgage Centres was born. Since then, Phil has been influential in the opening of several new offices as the business continues to grow.
Qualifications
Financial Planning Certificate: 1, 2 & 3 | Year Attained: 1992
Certificate in Mortgage Advice and Practice (CEMAP) | Year Attained: 2001
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