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How do interest-only mortgages work?
With an interest-only mortgages you only pay off the interest amount each month. This means at the end of the mortgage term, you'll need to repay the capital you borrowed.
| Mortgage term | Interest rate | Monthly interest repayments | Total monthly interest repayments | |
|---|---|---|---|---|
| 25 years | 5% | £751 | £225,165* |
*This example assumes your interest rate will remain the same over the full length of your mortgage. It's likely to change depending on the deal length, and whether you stay on your lender's standard variable rate or remortgage to a new deal.
In this example, when the mortgage term ends, you'll still owe the £180,000. So it's crucial that you have a repayment plan as the lender will want to know what this is.
Repayment plans for interest-only mortgages
If you're buying a buy-to-let, you can normally sell the property at the end of the mortgage term to pay back the capital you owe.
If you've used an interest-only mortgage to purchase your home, you might be able to pay off your interest-only mortgage using a lump sum of cash you've inherited. But you'll usually need to save up using either:
A savings account or ISA
An investment fund
An endowment policy
If you don’t have the funds, you’ll need to sell off your property to pay back the lender, but you'd need to find somewhere else to live.
This might work for you, for instance, if you’re planning to downsize. Alternatively, you could try and take out a new mortgage – either on an interest-only or repayment basis.
If you have a retirement interest-only mortgage, this will generally only need repaid once you die, move into long-term care or sell the property. They are similar to other types of equity release schemes such as lifetime mortgages.
What's the difference between interest-only and repayment mortgages?
Repayment mortgages:
Most property purchases are made using a repayment mortgage. This is when each monthly repayment pays off a portion of the amount borrowed, plus some interest. At the end of the mortgage term, you won't owe the lender any more money, and therefore you’ll own your house outright.
Repayment mortgages usually cost more each month, but less over the mortgage term. You'll normally find lower interest rates available for repayment mortgages than you will for an interest-only deal.
Interest-only mortgages:
By comparison, interest-only mortgages don’t require you to repay the capital amount that you owe until the end of the mortgage term – they only require you to pay off the interest each month. This means you will still owe the original amount borrowed once your mortgage term has come to an end.
Interest-only mortgages are not cheaper than repayment mortgages overall, but they typically cost less each month.
Can I get an interest-only mortgage?
Interest-only residential mortgage deals haven't been easy to get for a property since the financial crisis in 2008. Lenders are now more cautious about offering these deals as they’re seen as much riskier.
To get one, you need to meet tough affordability criteria. This includes having a large deposit and a solid repayment plan in place for how you'll pay off the balance at the end of the term.
If you do manage to get a residential interest-only mortgage, your lender may want to check from time to time that your repayment plan is on track.
However, if you're planning on purchasing a buy-to-let property, there are still lots of interest-only mortgages available to landlords. That's because lenders have the security that the home can be sold at the end of the term.
If you're unable to get an interest-only mortgage but still looking to keep monthly repayments as low as possible, you should compare mortgages and speak to a mortgage broker to try and find the best deal for you.
What if I can't repay the loan at the end of an interest-only mortgage?
If you reach the end of your interest-only mortgage term and you're unable to repay the loan using savings or another repayment strategy, you will need to sell the property.
If the property can't be sold for enough money to cover the loan, your other assets may be at risk.
It's very important to have a robust repayment plan in place when taking out an interest-only mortgage. You should check in on this regularly.
If you're worried about being able to repay the full loan at the end of the term, you might be able to switch to a repayment or part-and-part mortgage so that you can pay the borrowing amount back in smaller chunks.
Advantages and disadvantages of interest-only mortgages
Advantages
Disadvantages
What is the best interest-only mortgage for me?
The best interest-only mortgage is one that suit you and your circumstances. Look out for deals that offer affordable monthly payments and low repayment charges.
However, be aware that interest-only mortgages will generally charge higher interest rates than a standard repayment mortgage. And you'll normally require a higher deposit.
Our expert mortgage broker, Mojo, can give free advice and help you find the most suitable interest-only mortgage deal for you.
Interest-only mortgage FAQs
What is a part and part mortgage and can I get one?
Some lenders offer part-and-part mortgages, where part of your mortgage is interest-only, and the other part is a repayment mortgage. It will make your monthly payments a bit cheaper, but at the same time, you'll be paying off some of the balance.
That means you'll have less to repay at the end, and your interest payments will gradually decrease.
These are less risky than a mortgage that's fully interest-only but you will still have a sum to pay back when the mortgage term ends. This means you'll still need some kind of repayment plan in place.
Speaking to a mortgage broker might help you work out if a part-and-part mortgage is right for you.
Which lenders offer interest-only mortgages?
While interest-only mortgages for residential properties are far rarer than they used to be, several lenders offer interest-only products for buy-to-let properties, including:
Natwest
Virgin Money
Accord
Clydesdale Bank
HSBC
A whole-of-market mortgage broker can compare deals from different lenders to help you find the best interest-only rate.
What are the alternatives to interest-only mortgages?
The alternatives to an interest-only mortgage are:
Part-and-part mortgage
Repayment mortgage
A part-and-part mortgage combines repayment and interest-only mortgages. You pay a portion, of your total borrowing amount through your monthly repayments. This means you'll have less to repay at the end of the mortgage term compared to taking out an interest-only mortgage.
However, you will still need to make sure you have a robust repayment strategy in place for when your mortgage term ends. It also means your monthly payments will be higher compared to a full interest-only mortgage.
A repayment mortgage means you pay the amount you borrowed back through your monthly repayments, in addition to the interest payments. This is how most residential mortgages work.It means that once you reach the end of your mortgage term, you'll have paid off what you borrowed and will own your property outright.
Can I find an interest-only buy-to-let mortgage?
Many lenders offer interest-only buy-to-let mortgage deals. Landlords often use interest-only mortgages to manage their property portfolio, and the money that would have paid off the capital might go into maintaining and renovating the property.
Can you pay off an interest-only mortgage early?
Yes, many lenders will allow you to do this, but you may have to pay an early repayment charge (ERC). Check your terms and conditions carefully, and factor this in when choosing a lender.
How big a deposit will I need for an interest-only mortgage?
This will depend on the lender, but generally, you will need to put down a larger deposit for an interest-only mortgage than for a repayment mortgage.
Most are likely to want a deposit of at least 25%, but some may ask for 40% or more.
Is it worth getting an interest-only mortgage?
An interest-only mortgage for a residential property can be a useful stop-gap if you are struggling to pay off your mortgage – for example, if you have been made redundant or need to take time off work. You can ask your lender to switch you to an interest-only arrangement while you get back on your feet. This can be a better option than having a mortgage repayment holiday where your interest will start to add up.
Also, interest-only mortgages are a popular option for buy-to-let investors. This is because it allows lower monthly repayments, meaning they can be sure the rental payments will cover at least 125% of them (which is usually the minimum requirement).
Retirement interest-only mortgages can also be an option if you're an older borrower. They allow you take out an interest-only mortgage on a property, and the capital is only repaid when you die or move into long-term care.
Are interest-only mortgages cheaper than repayment mortgages?
Interest-only mortgages usually have lower monthly repayments compared to a repayment mortgage. However, the amount you pay overall will usually be higher as the interest rates are less attractive.
Plus, your mortgage loan doesn't reduce over time as it does with a repayment mortgage. So, you're still paying interest on the full loan amount for the lifetime of the mortgage.
Can I switch between repayment and interest-only?
Yes, some lenders will allow you to switch from one type of mortgage to the other.
You might be able to do a product transfer with your existing lender, or you might be able to remortgage to a new deal either with your existing lender or another one.
Can I get an interest-only mortgage with bad credit?
It can be challenging to get an interest-only mortgage with bad credit. It may be easier to qualify for a part-and-part mortgage if you don’t want a full repayment mortgage.
Can I get a joint interest-only mortgage?
Yes, you can apply for an interest-only mortgage with someone else. However, you would still need to meet all the lending criteria required, including having a viable repayment strategy in place.
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