Introduction
When looking for the best mortgage for your current situation, choosing from the various options available can be overwhelming, particularly when encountering terms like “interest-only mortgages.” While less popular than traditional repayment mortgages, they still may offer attractive solutions for certain homebuyers in the UK. What exactly are interest-only mortgages and how do they work? To help make an informed decision we have written this comprehensive guide covering everything you need to know about a mortgage that is interest-only.
Unravelling the Concept: What is an Interest-Only Mortgage?
An interest-only mortgage, as its name suggests, is a type of mortgage where your monthly payments cover only interest on what you’ve borrowed; your capital remains unchanged throughout its duration compared to repayment mortgages where payments chip away at both interest and capital amounts over time.
Repaying interest-only mortgages requires careful planning since you must repay the full loan amount at the end of their terms – making regular monthly repayments more affordable, but needing to come up with a way of repaying this lump sum amount at once.
The Mechanics of Interest-Only Mortgages
So how exactly does an interest-only mortgage work in practice? Each month, you’ll make payments to your mortgage lender that only covers the interest on your loan rather than its capital, which means your debt remains the same throughout its term.
At the end of your loan term, it is expected that you repay in full the full loan amount owed. This should be accomplished using a repayment vehicle such as savings accounts or investments; failure to do so could result in losing your home. Ensure a reliable vehicle for repayment by creating savings accounts or investing your assets accordingly.
The Pros and Cons of Interest-Only Mortgages
A mortgage that is interest-only come with their own set of advantages and disadvantages; understanding them will help you decide if this type of loan is the one for you.
Advantages
- Lower Monthly Payments: Since only paying interest each month can significantly lower monthly repayments compared to a repayment mortgage, which could prove especially advantageous if you have other financial commitments or are anticipating higher income in the future.
- Flexibility: Interest-only mortgage loans offer a degree of flexibility. If you find yourself with extra funds available to make overpayments and thus lower the overall cost of the loan.
Disadvantages
- Total Cost: An interest-only mortgage may have lower monthly payments, but will cost you more in the long run due to the fact you are not reducing the mortgage loan.Repayment Vehicle: At the end of your loan term, it is crucial that you have an effective plan in place to repay the mortgage in full – this could involve savings, investments, or even selling property.
Interest-Only Mortgages vs Repayment Mortgages
Before choosing the ideal mortgage option for yourself, it’s essential to understand the differences between interest-only and repayment mortgages. Each has its own set of advantages and disadvantages – choosing which option best meets your circumstances will determine which path is taken.
What Is Repayment Mortgage Lending?
Repayment mortgages (also referred to as capital and interest mortgages) are the most prevalent form of home financing available today. Your repayments go toward both interest and capital balance of your loan, meaning that by the end of your mortgage term, you will have paid off every penny and fully owned your home outright.
Interest only mortgage vs repayment mortgage graph
Key Differences
Monthly Payments
- Interest-Only Mortgage: Your monthly payments only cover the interest on the loan. This results in lower monthly repayments compared to a repayment mortgage.
- Repayment Mortgage: With this type of mortgage loan, your monthly payments include both interest and capital loan amount owed compared to an interest-only mortgage which results in higher monthly repayments than would otherwise be necessary.
Total Cost
- Interest-Only Mortgage: While monthly payments may be lower, their total cost can be higher as the capital balance does not reduce over the term of the loan.Repayment Mortgage: While monthly repayments will likely be higher, the total costs could actually be less as you gradually reduce the capital balance.
Repayment of capital
- Interest-Only Mortgage: At the end of each term, it is your responsibility to repay in full the entire loan amount owing. A solid repayment strategy should include savings or investments as well as selling off property as part of this repayment strategy.Repayment Mortgage: With this type of loan, capital amounts are gradually paid back over its term. By its conclusion, all of your debt will have been satisfied.
Example: Interest-Only vs Repayment Mortgage
An interest-only mortgage with 5% interest over 25 years would cost monthly mortgage payments of £1041.67; totaling to £312,501 over time. You would still owe back your original deposit when your deal comes to an end, however.
Compared with a £250,000 repayment mortgage with the same rate and term, your repayments would be £1,461 a month. You would also clear the capital over the 25 year term. You would pay £188,443 in interest over the full term – which makes it £124,058 cheaper than choosing an interest-only mortgage.
To ensure you benefit from lower repayments, speak to our team and we will search the market for the lowest mortgage rates currently available on both interest-only and repayment mortgages.
Learn more: The Different Types of Mortgage Explained
Which is Right for You?
Making the choice between an interest-only mortgage and repayment mortgage ultimately boils down to your finances and long-term goals. An interest-only loan might make sense for you if you prefer lower repayments with a reliable plan in place to repay the mortgage balance at the end of the term; on the other hand, repayment mortgages might provide more financial flexibility if your goal is gradual debt reduction and owning outright by end of term – it’s wise to consult a professional mortgage advisor or broker in making this important decision for yourself.
Introducing part and part mortgages
Part Repayment, Part Interest Only Mortgages combine interest-only and repayment methods. One portion requires you to pay both the interest and capital, gradually paying down the mortgage; for the other, only interest is payable, keeping monthly costs down while still repaying the capital at the end of the term. While this mortgage type offers flexibility, careful planning may be required as not everyone may find this suitable.
What is an interest free mortgage?
Interest-free mortgages do not really exist in the mainstream mortgage market. The products sometimes marketed as interest-free mortgages are more accurately described as:
- Low or fixed rate mortgages – They have interest rates of 0% or close to 0% for a set period of time, after which regular interest rates apply. The interest is just deferred.
- Offset mortgages – Borrower deposits are held in a savings account offsetting the mortgage balance, reducing interest costs but not eliminating them.
- Islamic/Sharia-compliant mortgages – They avoid interest through cost-plus financing but still have monthly fees.
- Deferred interest schemes – Interest accrues but payments are deferred until the end of the term.
The mortgage industry works by charging interest over the long run, so a product with zero interest wouldn’t line up with how lenders make money. Sometimes marketing language can make certain mortgages sound interest-free when they’re not. But the bottom line is that true interest-free home loans aren’t practical or on the market. However, don’t get too caught up in the terminology – feel free to WhatsApp one of our knowledgeable mortgage advisors. We’re happy to provide straightforward explanations and help clarify any confusion around interest rates. Our team looks forward to assisting you in understanding your options.
How much you could borrow?
Mortgage providers will allow you to borrow a loan amount of up to 75% of a buy to let property however an interest-only mortgage on a residential mortgage can be higher.
The exact amount you will be eligible to borrow will depend on whether you’re buying a residential or a buy-to-let property alongside a number of other factors, the most prominent of which will be your monthly income.
Mortgage Affordability Calculator
Each lender has their own affordability calculator which they use to determine how much you can borrow for a mortgage. A mortgage broker like ourselves can have access to a tool that looks at every affordability calculator of 90+ mortgage lenders. For a more accurate figure, get in touch with our team and we will calculate the amount you may be able to borrow based on your personal circumstances.
Interest only mortgage repayment calculator
You can compare the monthly cost of a capital repayment mortgage vs an interest-only mortgage using the mortgage repayment calculator below.
Who is Eligible for Interest-Only Mortgages?
Interest-only mortgages aren’t suitable for everyone, and mortgage lenders typically have stricter eligibility criteria compared to repayment mortgages. Here are some of the key requirements:
- Income and Affordability: In order to meet a lender’s minimum income threshold, you need to demonstrate that your repayments can be afforded and meet their minimum income threshold requirements.
- Credit History: While your credit rating may be less impactful than it would be for a capital repayment mortgage, serious credit issues could still pose a problem.
- Age: Most lenders have minimum and maximum age thresholds.
- Experience: If you’re purchasing for investment purposes, some lenders prefer that you have prior landlord experience.
- Deposit: The loan-to-value (LTV) amount offered on a mortgage that is interest-only is typically lower than for mortgages that are repayment, meaning the deposit requirement is greater.
Repayment Vehicles for Interest-Only Mortgages
As mentioned earlier, having a reliable repayment vehicle in place is crucial for an interest-only mortgage. Here are some of the acceptable repayment vehicles:
- Sale of the Property: This is a popular option, especially for investment properties. You might choose to sell a residential property at the end of a longer interest-only mortgage term by downsizing to a smaller dwelling and using the equity to repay the original loan.
- Investments: There are a number of investment options that may be deemed acceptable repayment vehicles, including ISAs, stocks and/or shares, bonds, unit trusts, and endowment policies.
- Cash Repayment or Pension Lump Sum: You could choose to use personal savings, an inheritance, or the tax-free lump sum taken from your pension pot to repay the loan.
How to Secure an Interest-Only Mortgage
Securing an interest-only mortgage for buy-to-let or residential properties can be done directly with lenders; however, to access the most cost-effective deals it’s advisable to consult a mortgage broker first. Brokers have access to every lender offering interest-only loans and can search them all on your behalf to find one with lower interest-only payments.
Which Lenders Offer These Mortgages?
An increasing number of lenders are re-introducing mortgages that are interest-only, although some have strict criteria around minimum income and deposit requirements. Some lenders are more flexible, so it’s worth discussing with a mortgage advisor to find the provider that best suits your circumstances.
Here are some examples of three popular UK lenders offering interest-only mortgages to qualifying customers:
| Lender | Minimum Income (Single) | Minimum Income (Joint) | Deposit | Minimum Equity | Important Notes |
|---|---|---|---|---|---|
| Barclays | £75,000 | £100,000 or one applicant earning £75,000 | On application | No | Cannot rely on property sale to repay loan |
| Nationwide | £75,000 | £100,000 | 40% | Varies by region: £300,000 – Greater London £250,000 – Outer South East £200,000 – all other UK regions | New purchase and remortgage only maximum term of 25 years (or retirement if sooner) maximum loan amount of £2 million. Not available to first time buyers |
| Halifax | £100,000 | £150,000 or one applicant earning £100,000 | 50% (for sale of mortgaged property as a possible repayment strategy) | £200,000 (for sale of mortgaged property as a possible repayment strategy) | Sale of mortgaged property as a possible repayment strategy only for a maximum loan of 50% loan-to-value on interest only |
The table gives you a good idea of lending criteria as of May 2023 but shouldn’t be used as financial advice. The 2023 mortgage market is seeing lenders change their lending criteria on a monthly basis. However, as with any financial decision, I recommend reaching out to these lenders directly or speaking with one of our mortgage advisors to get the most accurate and personalised information.
How Long Can You Have One?
Interest-only mortgage terms can range from 5 to 25 years, depending on the borrower’s individual situation. In some cases, lenders may offer longer mortgage terms of up to 40 years for individuals deemed suitable by them. If you can demonstrate your ability to pay off the mortgage within two years or less, loan providers might approve your request for a shorter-term mortgage option.
What Rates to Expect
Interest-only mortgages come with both variable and fixed-term interest rates; fixed term rates currently offer greater stability due to rising interest rates. Your rate depends on a range of factors including type of loan taken out, deposit size and total length and amount financed over a specified timeframe.
Interest-Only Mortgages in the current UK Market
Mortgages that are interest-only have experienced a comeback in the UK market in recent years. Though many lenders withdrew their interest-only offerings following 2008’s financial crisis, an increasing number are offering this type of deal again – though with stringent criteria imposed for interest-only lending such as minimum income requirements and equity deposits/deposit requirements.
Our Mortgage Advisers’ Thoughts on Interest-Only Mortgages
People attracted to a mortgage that is interest-only are usually drawn in by the prospect of lower monthly payments; however, most are unaware of its stringent criteria and requirements. Typically interest-only mortgages are most accessible for individuals with high incomes, considerable savings accounts or significant equity in their property.
Generally, you would need to have savings or investments equivalent to the amount you’re borrowing. Alternatively, the sale of your property could serve as a repayment vehicle, but usually, you can only borrow up to 50% of the property’s value. Additionally, after taking out a mortgage on a property you should ideally maintain at least £250,000 of equity in it.
While lower monthly payments may seem appealing, securing such a mortgage may not always be practical due to its stringent requirements. As always, it’s wise to carefully evaluate your personal financial circumstances and consult a qualified mortgage adviser in order to identify whether an interest-only mortgage could be a suitable option for you.
Conclusion
Interest-only mortgages can be an attractive option for certain homebuyers in the UK, but it’s essential that they fully comprehend all their pros and cons before making a decision. While lower monthly payments might tempt buyers, remember to create a solid repayment plan and consider potential higher overall costs before making your choice. For best results, it is always advisable to seek advice so you really understand how interest-only mortgages work and how to get a mortgage. Speak to an experienced mortgage broker prior to making such decisions on your own.
Frequently Asked Questions
Is it worth getting an interest-only mortgage?
An interest-only mortgage depends on your current financial circumstances and goals. They may be ideal for those seeking lower monthly payments with a solid plan in place for repayment at the end of their term; however, they can be risky without an established repayment strategy in place.
What are the requirements for an interest-only mortgage?
Attracting lenders who offer a mortgage that is based on interest-only requires showing proof of income and meeting certain credit history standards; additionally, they may request larger deposits as well as age criteria that need to be fulfilled before being approved for one.
What is a disadvantage of an interest-only mortgage?
An interest-only mortgage has one key drawback - having to repay the full loan amount at the end of its term, even though monthly mortgage payments may be lower as capital remains constant during repayment. This could result in higher total costs as interest payments don't reduce during its lifespan.
How much is a 100k interest-only mortgage per month UK?
A £100,000 interest-only mortgage will cost approximately £250 each month depending on its interest rate and term; at 3% over 25 years this would translate to approximately £250 as monthly interest payments.
How does an interest-only mortgage work?
With an interest-only mortgage, you only pay the interest on the loan each month. The capital amount remains the same throughout the term. At the end of the term, you must repay the full loan amount.
How risky are interest-only mortgages?
A mortgage that is interest-only can be risky without an effective mortgage repayment plan or strategy to repay the capital at the end of mortgage term. If investments or property sales fall short, leaving you with a significant debt that must be addressed quickly.
Can you get interest-only mortgages anymore?
Yes, interest-only mortgages are still available although not as frequently. Lending criteria tend to be stricter for these mortgages and some lenders only provide them to high-net-worth individuals.
Do any banks offer interest-only mortgages?
Yes, some banks and mortgage lenders in the UK still offer mortgages that are interest-only. However, they often have stricter eligibility criteria and may require a larger deposit compared to mortgages that are based on a repayment basis.
