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Interest Only Mortgages

Interest-only mortgages are a form of lending against your home, whereby the monthly payments cover only the interest element of the loan. This means that each payment does not include any repayment of the original value – the capital – that was borrowed.

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Interest-only mortgages

Choosing between an interest-only and a repayment mortgages

Repayment mortgages, in contrast, include monthly repayments of both an interest element, and a proportion of the capital borrowed.

One of the main attractions of an interest-only mortgage is the lower monthly repayment. However, the important factor is to understand that none of the capital is being repaid and to have a plan in place to manage this. A repayment plan for the capital element of an interest-only mortgage is referred to as a repayment vehicle.

Repayment vehicles

Such a vehicle could include:

  1. An endowment policy 
  2. A pension scheme
  3. An ISA savings account
  4. The resale of the property itself at the end of the term

Lenders offering interest-only mortgages each have their own criteria against which repayment vehicles they will accept.

Comparable interest rates

From a cash flow perspective, an interest-only mortgage is an appealing option. However, since interest is charged on the original loan value for the lifetime of the mortgage, it is important to understand that the overall interest paid will be higher. A repayment mortgage attracts interest at a reducing rate as the capital owed is brought down. Finding the best deal can be confusing with any number of mortgage offers, benefits and contrasting rates available at any one time. If you are unsure of which mortgage product is best for you, or whether to choose between a repayment or interest-only mortgage, give the team at Revolution Finance Brokers a call, and we will help you to make the most informed decision! As an example, consider that you are purchasing a property at £232,000 and have a 25% deposit payment available. This leaves a mortgage required of £174,000 and assuming a 25-year loan basis.

  1. At 3% interest, the monthly payment on an interest-only mortgage will be £435 and the total interest paid over 25 years £130,500. The monthly repayment on a repayment mortgage will be £825 and the total interest paid over 25 years £73,538.
  2. At 4% interest, the monthly payment on an interest-only mortgage will be £580 and the total interest paid over 25 years £174,000. The monthly repayment on a repayment mortgage will be £918 and the total interest paid over 25 years £101,531.
  3. At 5% interest, the monthly payment on an interest-only mortgage will be £725 and the total interest paid over 25 years £217,500. The monthly repayment on a repayment mortgage will be £1,017 and the total interest paid over 25 years £131,156.

Part-and-part mortgages

Part-and-part mortgages are a blended product combining both interest-only and repayment mortgages. This solution is ideal for property investors who have a repayment vehicle in place, but that only covers part of the total property purchase. This means that a proportion of the mortgage can be repaid as a repayment mortgage, and the balance paid as interest-only, with the assurance of a repayment vehicle in place to cover the balance. The benefit of part-and-part mortgages is that it provides a compromise between the two mortgage options. Overall, monthly payments will be lower than for a simple repayment mortgage, but will also account for the capital repayments required to lower the balance outstanding to match the value of the repayment vehicle.

Selecting an interest-only mortgage

Interest-only mortgages are best suited to buyers who understand the concept and whose finances and circumstances make them eligible. Please note that not all lenders offer interest-only options, so if you think this is right for you, please give the team a call and we can advise on the best rates for your circumstances. Some buyers in areas where housing prices are very high consider interest-only mortgages a more cost-effective option than renting a residence. Buy-to-let investors often prefer interest-only mortgages to reduce cash flow outgoings and choose to make instalments against the outstanding capital at regular periods. This system also provides a viable opportunity to expand a property portfolio in an area where the value of a property is expected to rise, thus delivering a profit at the point of resale after the capital has been repaid.

Choosing an interest-only mortgage provider

Interest-only mortgages are less common than they used to be and therefore are not available through all lenders. If you need help finding an interest-only mortgage lender, give us a call! Revolution Finance Brokers work with clients from first-time buyers to property investors and pride ourselves on finding the best product for every client. If you need any advice about finding the best mortgage for you or working out which option will suit you, get in touch.

FAQs

What does interest-only mean?

An interest-only mortgage is one where your regular payments account for only the interest payable on the mortgage lending you have been given. That means that no part of the capital is being repaid and you will need to have a plan in place to repay this.

What are the key differences between interest-only and repayment mortgages?

The difference is that a repayment mortgage will include a proportion of interest, and a proportion of capital repayment in every instalment. This means that the capital you owe will gradually decrease, and usually the amount of interest vs. the amount of capital being paid off in each repayment will reduce as the interest is brought down and the amount of interest you pay on the outstanding balance reduces. Interest-only mortgages repay only the interest on the original amount borrowed, meaning that this will remain outstanding and need to be paid back at the end of the mortgage term.

Which is cheaper - repayment or interest-only?

An interest-only mortgage might appear to be cheaper since the monthly payment will be lower. However, usually interest-only mortgages work out to be more expensive, and the total interest payable over the life of the mortgage will be higher than that for a repayment mortgage. This is because the interest on a repayment mortgage reduces every month as the capital outstanding comes down.

What are part-and-part mortgages?

Part-and-part mortgages are a combination of interest-only and repayment. This is often an ideal solution for borrowers who have a repayment vehicle in place - say a savings account - but this doesn’t cover the full balance. The homeowner can pay back the borrowing on a repayment basis until the capital owed is reduced to match the finances they have available in their repayment vehicle, and they can then pay on an interest-only basis until the end of the mortgage term.

Who are interest-only mortgages suited to?

Anybody can apply for an interest-only mortgage, although many lenders will have criteria around who can apply or which repayment vehicles they consider acceptable. First-time buyers tend to prefer interest-only mortgages since it helps them to purchase their first home without a heavy monthly repayment required. Remortgages may also be on an interest-only basis. Buy-to-let investors or property investors also tend to prefer interest-only mortgages to reduce their cash outlays per month to ensure they are making a profit on rental incomes. If they plan to resell the property at the end of the mortgage term and there is a strong likelihood that the value will have increased, this can act as a suitable repayment vehicle.

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FCA disclaimer

*Based on our research, the content contained in this article is accurate as of most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information. The information on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs. Some types of buy to let mortgages are not regulated by the FCA. Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.

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