An interest-only mortgage is one where you only pay off the interest on a home loan, rather than repaying any of the capital you borrowed. You can also get interest-only remortgages.
Interest-only mortgages cost far less each month than repayment mortgages because your monthly repayments don't reduce the overall debt. At the end of the term, you'll still owe all the capital you originally borrowed - and you'll have to pay it back in full.
Here's an example. If you take out a £180,000 interest-only mortgage over 25 years with an interest rate of 3.5%, the monthly interest repayments would be £525 (£157,644 in total). But when the mortgage ends, you'll still owe £180,000.
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With interest-only mortgages, you need to find a way to pay off the balance at the end of the term. When you apply for an interest-only mortgage, you need to tell the lender how you plan to do this.
If you're a landlord, you might have a buy-to-let interest-only mortgage (BTL). This is the most common interest-only mortgage nowadays and is taken out for a rental property. You can sell the property at the end of the mortgage term and use the money you make to pay off the capital you owe.
Alternatively, you might have an interest-only residential mortgage for a property you live in. If that's the case, you'll either need to save up or invest during the mortgage term in order to repay the balance when the term ends.
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.
Interest-only mortgage deals haven't been easy to get since the financial crisis in 2008. Lenders are now more cautious about offering these deals as they’re seen as much riskier.
There's only a handful of lenders who will offer interest-only mortgages. To get an interest-only mortgage, 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 an interest-only mortgage, your lender may want to check from time to time that your repayment plan is on track.
However, when it comes to getting an interest-only mortgage, buy-to-let customers are in luck. 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.
The best interest-only mortgages are the ones that offer affordable monthly payments and low repayment charges. Interest-only mortgages will charge higher interest rates than a standard repayment mortgage.
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're guaranteed to owe nothing, and you’ll own your house in full.
By comparison, interest-only mortgages don’t make inroads into the capital amount that you owe - 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. You can work out how much you'd pay using an interest-only mortgage calculator.
Repayment mortgages usually cost more each month, but less over the mortgage's term. You'll find it easier to get a low-interest mortgage for repayment than you will to get an interest-only deal.
The monthly payments are likely to be far lower
You may have spare cash, which you could use to improve your home and increase its value
Buy-to-let landlords can save their rent profits and put it towards paying off the mortgage at the end
You could make a profit if your investments perform well, which could help you pay off your mortgage early
Interest-only mortgages cost you more in the long run because you'll pay interest on the whole amount borrowed for the entire term
You won't officially own your house, even when your mortgage ends. You still have to pay off the capital sum
There's an element of risk if you're hoping your property will be worth enough to pay off the balance at the end
The strict criteria for getting an interest-only mortgage means not everybody can get one and you may need a bigger deposit
As interest-only mortgages allow you to pay off just the interest each month, you will still owe the original amount borrowed once your mortgage term has come to an end.
This means you still need to repay the capital. This could be from savings, an inheritance or selling the property. Or you may be able to get another mortgage instead.
Many lenders offer interest-only buy-to-let 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. You can compare buy-to-let mortgages here.
Yes, many lenders will allow you to do this, but you may have to pay an early repayment charge. Check your terms and conditions carefully, and factor this in when choosing a lender.
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.
Yes, 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.
An interest-only mortgage 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.
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.
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.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE
|Based on borrowing||£170,000 over 25 years||The overall cost of comparison||4.46% APRC Representative|
|Initial rate||3.34% fixed for 2 years (24 instalments of £884.45pm)||Subsequent rate (SVR)||4.66% variable for the remaining 23 years (276 instalments of £944.66pm)|
|Lender fee||£517||Total amount payable||£282,470.34|
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