Almas Uddin
Founder and Mortgage Advisor
05 Jan 2024
Repayment vs Interest-Only Mortgages: The Pros and Cons
Choosing the right type of mortgage can be complicated - and interest-only is one option. This means that you borrow the money to finance your property purchase, pay only the interest over the term, and need to have a way to repay the original value at the end of the period.
Capital repayment and interest-only mortgages both offer pros and cons, which we'll discover in this article.
For independent advice about the best mortgage options for your circumstances, contact mortgage brokers on 0330 304 3040 or drop us a message to [email protected].
How Do I Choose Between Repayment and Interest-Only Mortgages?
The big difference is that on an interest-only mortgage, your monthly payment is only for the interest element of the loan. You need to repay the amount borrowed when the mortgage ends.
A capital repayment mortgage means each month you repay a proportion of the capital and an element of interest.
How Do Capital Repayment Mortgages Work?
This mortgage is the most common residential property loan and means that you make a payment each month, with the total outstanding reducing over time.
When you reach the end of the term, the borrowing has been repaid in full.
As time goes on, the interest element of your monthly repayment reduces as you pay back more of the debt.
What are the Benefits of Choosing a Repayment Mortgage?
The key reasons a repayment mortgage can be an attractive option are:
- Assurances that your debt is being repaid gradually over the mortgage term.
- Options to extend your loan term to reduce your monthly payments. Most mortgages are around 25-years, but you can apply for a period as long as 35 or even 40 years to help manage your budget.
- Lower deposits - for first-time buyers, the deposit can be make or break. Repayment mortgages can be for as much as 95% of the property value, although 85% is more common. Interest-only mortgages, on the other hand, usually need at least a 25% deposit and sometimes significantly higher.
What are the Benefits of an Interest-Only Mortgage Over Repayment Borrowing?
Interest-only mortgages can offer a competitive deal, depending on your circumstances.
- Monthly payments are lower. Given that you are only paying the interest, the regular costs are much less than for a repayment mortgage. Below we have illustrated the difference between the two categories.
- Potential to repay the debt faster. If you already have your exit strategy in place, you might be able to use this to repay the capital debt quicker.
- Options to downsize. Many homeowners who plan to downsize use interest-only lending to manage their budget, with the expectation that at the end of the term the property will be sold, the proceeds used to repay the debt, and the difference used to purchase a new, smaller, property.
Here is an illustration of the monthly costs and total repayable on an interest-only vs repayment mortgage, based on a £200,000 mortgage at 3% interest:
|
|
Interest-Only Monthly payment
|
Total Repayment Value
|
Repayment Monthly Repayment
|
Total Repayment Value
|
|
20-year mortgage
|
£500
|
£319,938
|
£1,109
|
£266,169
|
|
25-year mortgage
|
£500
|
£349,922
|
£948
|
£284,478
|
|
30-year mortgage
|
£500
|
£379,906
|
£843
|
£303,495
|
What is a Retirement Interest-Only Mortgage?
This product works like a regular interest-only loan, but often with no term end date. Instead, you pay the monthly interest, and when you pass away or go into care, the property is sold and used to repay the capital.
Retirement interest-only mortgages are usually available after the age of 55, and up to 85 with some lenders having no upper limit.
Can I Use an Interest-Only Mortgage for a Buy to Let Investment Property?
You can, and BTL mortgages are often on an interest-only basis. Landlords use the lower monthly repayments to manage their cash flow and build their portfolio, selling a property at the end of the term to repay the original debt.
What Repayment Vehicles are Suitable for an Interest-Only Mortgage?
Repayment vehicles are essential when applying for an interest-only mortgage, as you need to have a stable way to repay the original debt at the end of the term.
Many applicants wish to put forward the sale of their property as an exit strategy, but this can be an uncertain prospect.
If the property market fluctuates, your home might not be worth as much as you are anticipating in the future. So some lenders will not accept the property sale as an acceptable repayment vehicle.
In other cases, property sales are acceptable, but only if a minimum value of equity is held - as a cushion to assure the lender, they will recoup the borrowing. This minimum can be from £100,000 but is usually at least £150,000.
More common repayment vehicles include:
- Pension fund lump sum withdrawals.
- Sale of investments such as stocks, shares or trusts.
- An inheritance or trust fund.
- Cashing in savings or an ISA.
In most cases, you will need to provide documentation evidencing the existence of your repayment vehicle, as well as independent valuations and forecasts.
Can Interest-Only Mortgages be Advantageous?
They can be, in the right scenarios.
While interest-only lending can be subject to a great deal of controversy, this is around lenders in the past accepting unsuitable repayment vehicles, meaning that homeowners faced a repossession scenario at the end of the loan term.
One of the most significant issues was around endowment policies, which failed to perform as anticipated. This repayment vehicle is, therefore, now rarely considered acceptable.
Can I Remortgage from Interest-Only to Repayment Lending?
You can indeed, and if you are in any doubt as to the growth or value of your repayment vehicle, remortgaging can be an excellent option to avoid leaving it till the end of the term and finding yourself unable to repay the debt.
Remortgaging is available in any number of ways:
- Making additional payments towards an interest-only mortgage balance where permitted by the lender.
- Cashing in a repayment vehicle early to repay the capital balance.
- Porting to a repayment mortgage with your same provider.
- Remortgaging with a different lender.
- Switching to a part and part mortgage, with a proportion interest-only and a proportion capital repayment.
You might find it challenging to remortgage at, or past retirement age, but need to change from an interest-only mortgage.
In this situation, give us a call on 0330 304 3040. There are plenty of retirement-specific remortgaging options or lenders who do not set an upper age cap and will be happy to consider your application.
Can I Get an Interest-Only Mortgage with an Adverse Credit History?
Bad credit is a common scenario, and with credit files going back for six years, you might find that a high street bank refuses to lend, even against a problem that has since been repaid and resolved.
If you are concerned about your credit rating, be sure to access a copy of your file, which enables you to understand your credit score and correct any errors.
There are specialist bad credit lenders who offer flexible terms for applicants even when any of the below issues show on your credit report:
- Late payments or defaults.
- CCJs or mortgage arrears.
- IVAs and DMPs.
- Bankruptcy.
- Repossession.
Independent Broker Support with UK Interest-Only Lending
The key to finding the right mortgage for you is to seek independent advice from a broker who can help you understand the pros and cons of different mortgage types.
A lot depends on your circumstances, plans, and the property you wish to buy, and there is no one-size-fits-all solution since a mortgage is a significant commitment.
Contact Revolution Brokers on 0330 304 3040 or email us at [email protected] for access to any product on the market, and professional advice about your mortgage options.
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