- >
- Mortgage comparison>
- Guides>
- Should You Get An Interest Only Or Repayment Mortgage? | money.co.uk
Should you get an interest only or repayment mortgage?
When applying for a mortgage, you may be offered a choice between an interest-only deal and a repayment mortgage. This guide will help you choose the right mortgage for you.
Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage or any other debt secured on it.
The two main types of home-buyer loans are interest-only mortgages and repayment mortgages.
Interest-only mortgages can seem more affordable, but they tend to cost more overall; you’ll also need to find a way to pay off the loan at the end of the term.
Repayment mortgages cost more per month but less over the loan's lifetime - and will pay off your mortgage in full.
What is a repayment mortgage?
With a repayment mortgage, your monthly repayments are split into two parts: one part pays off the interest owed on your original loan, the second part goes towards reducing the loan amount.
The amount you pay each month is calculated to pay off the total amount owed by the end of the mortgage term, which is usually around 25 years.
Once you reach the end of the term, you will own your property outright.
How does a repayment mortgage work?
Each payment you make towards a repayment mortgage will make a dent in the amount you borrowed to buy your property.
But for the first few years, the proportion that goes towards the interest will be much greater than the amount that goes towards clearing your debt.
Over time, this changes because the interest owed decreases in line with the size of the loan.
In the last few years, the lion’s share of your payments should therefore go towards paying off your remaining debt.
If you have some spare cash available, you may be able to pay off your debt more quickly by increasing your payments by, say, £100 or £200 each month.
You can also often reduce the cost of your repayment mortgage by switching to a deal with a lower fixed- or variable-interest rate.
Breakdown of repayment mortgage costs
| Year | Monthly repayment | Of which interest | Total owed |
|---|---|---|---|
| Year 0 | £948 | £494 | £200,000 |
| Year 1 | £948 | £480 | £194,543 |
| Year 5 | £948 | £436 | £171,006 |
| Year 10 | £948 | £353 | £137,328 |
| Year 15 | £948 | £257 | £98,211 |
| Year 20 | £948 | £145 | £52,775 |
Example shows a 25-year repayment mortgage for £200,000 with an interest rate of 3%
Final payment = £0
Total repaid (before fees): £284,478
What is an interest only mortgage?
With an interest-only mortgage, your monthly repayments only cover the interest on your mortgage.
The amount you have to pay out each month is lower as a result. But the amount you owe your mortgage lender stays the same.
So if you borrow £200,000, you’ll have to find £200,000 to clear your debt at the end of the mortgage term, again usually around 25 years.
As a result, most lenders now require evidence of a repayment plan, as well as a substantial deposit, to consider you for an interest-only deal - unless you are applying for a buy-to-let interest-only mortgage.
How do interest-only mortgages work?
As the monthly payments on interest-only mortgages cover just the interest owed, they can often be hundreds of pounds cheaper than those for a repayment mortgage for the same amount.
On a 25-year, £200,000 loan with an interest rate of 3%, interest-only payments would be just £500, compared to nearly £950 with a repayment mortgage.
Unless you plan to sell the property at the end of the mortgage term, the idea is that you save or invest the difference into a repayment plan to ensure you have the cash to pay off your original loan amount.
Not everyone manages to do this, though. So your lender may want to check your repayment plan is on track at various points throughout the mortgage term.
Breakdown of interest only mortgage costs
| Year | Monthly repayment | Of which interest | Total owed |
|---|---|---|---|
| Year 0 | £500 | £500 | £200,000 |
| Year 1 | £500 | £500 | £200,000 |
| Year 5 | £500 | £500 | £200,000 |
| Year 10 | £500 | £500 | £200,000 |
| Year 15 | £500 | £500 | £200,000 |
| Year 20 | £500 | £500 | £200,000 |
Example shows a 25 year interest only mortgage for £200,000 with an interest rate of 3%
Final payment = £200,000
Total repaid (before fees): £349,922
What happens when my interest-only mortgage ends?
When your interest-only mortgage ends, you will need to pay off the original loan amount in one go.
Ways to do this include:
Withdrawing the required amount from your savings
Selling investments such as stocks and shares
Drawing down a lump sum from your pension fund
Selling the property (hopefully for a profit)
Taking out another mortgage (repayment or interest-only)
If you are concerned about being able to repay your mortgage on the given date, you may also be able to negotiate with your lender to extend the term.
Advantages and disadvantages of repayment mortgages
There are both advantages and disadvantages to taking out a repayment mortgage.
Advantages
You own your home at the end of the mortgage term
You pay less interest as the amount owed decreases
You can often qualify for better deals as your balance falls
Disadvantages
Your monthly payments are higher than with an interest-only deal
You only make small inroads into your debt in the early years
Representative example of a repayment mortgage
Amount borrowed: £200,000
Term: 25 years
Interest rate: 3%
Monthly payments: £948
Total cost (in interest): £84,478
If you're a first time buyer or looking to move house or remortgage, we can help you find the best mortgage deal to suit your needs.
Advantages and disadvantages of interest-only mortgages
There are both advantages and disadvantages to taking out an interest-only mortgage.
Advantages
Your monthly payments are lower than with a repayment mortgage
You may make a profit if your investments outperform
You can use the extra cash as you wish (e.g. for home improvements
Disadvantages
You will need to pay off the full amount borrowed in one go
You will pay more interest because the loan amount stays the same
You will need to monitor your investments as well as your mortgage
You could end up out of pocket if your repayment plan underperforms
Representative example of interest-only mortgage
Amount borrowed: £200,000
Term: 25 years
Interest rate: 3%
Monthly payments: £500
Total cost (in interest): £149,922
Which mortgage type is most suitable for me?
Generally, a repayment mortgage is a better and cheaper way to borrow the money to buy your own home.
That’s why many mortgage lenders now only offer residential interest-only deals to people with high incomes and large deposits - usually at least 50% of the property’s value.
However, interest-only mortgages are used more frequently in the buy-to-let market, where owners view the property as an investment they can sell to repay the loan.
If you meet the lending criteria for a residential interest-only deal, this type of mortgage can help you keep your monthly outgoings down in the short term. This may be helpful if you need the funds early on - for example, to pay for home improvements that will ultimately increase the value of your home.
Can you switch between interest-only and repayment mortgages
Yes, you can switch from a repayment mortgage to an interest-only mortgage or from an interest-only mortgage to a repayment deal.
However, switching from interest-only to repayment will mean having to prove you can afford the higher monthly payments.
Switching from a repayment deal to an interest-only mortgage can also be complicated and involves showing the lender your plan to pay off the loan at the end of the term.
Interest-only and repayment mortgage FAQs
What is the point of an interest-only mortgage?
Most people who take out interest-only mortgages do so in order to take advantage of the lower monthly payments charged with loans of this kind. They may do this to make the purchase more affordable in the early days or to retain greater flexibility over what they do with the money they don’t put towards paying off the loan amount.
Is an interest-only mortgage a good idea?
Interest-only mortgages can be risky and expensive and are unsuitable for most borrowers. However, some people manage to make money by choosing an interest-only deal because their repayment plan returns more than they need to pay off the original loan amount.
Why would you have an interest-only mortgage?
The main reason people choose interest-only mortgages is to reduce the amount they have to pay out every month. If you can afford the monthly payments on a repayment mortgage, that is usually the better choice.
Is interest-only best for buy-to-let?
You will pay lower monthly repayments with an interest-only mortgage. However, this does not mean interest-only deals are cheaper than repayment mortgages. In fact, they usually cost more overall because you pay interest on the full amount throughout.
When comparing, it’s important to look at the overall cost of the loan, including any extra fees as well as the headline interest rate. With interest-only mortgages, you also need to consider the costs involved in raising funds to clear the original amount borrowed.
Is interest-only best for buy-to-let?
Most buy-to-let landlords prefer interest-only mortgages, as the lower monthly payments help to reduce the cost of running a rental property. Lenders are also more comfortable offering interest-only mortgages to buy-to-let investors because they know that the property can easily be sold to pay off the initial loan amount at the end of the mortgage term.
Read More
Repayment Mortgage Rates - Best Repayment Deals December 2024 | money.co.uk
Compare every mortgage deal that puts your repayments towards paying back both the money you borrow and the interest that accrues. Every repayment you make will help reduce the total owed.
Read MoreCompare Our Best Interest Only Mortgage Rates December 2024 | money.co.uk
Learn all about interest-only mortgages, including whether you could get one and how to find the best interest-only mortgage deal for you.
Read More