When looking to get a mortgage, you have a choice between two mortgage types: repayment and interest-only. You can get good deals on both types of mortgages but if you’re looking to reduce your monthly payments, an interest-only mortgage could be right for you.
In this guide, we will go into further detail about interest-only mortgages, including how they compare to the repayment alternatives, and the criteria you need to pass to be eligible for this type of home loan.
Keep reading to learn more and then get in touch with our team of mortgage advisers if you would like a discussion about your mortgage options.
What is an interest-only mortgage?
With an interest-only mortgage, your monthly payments cover only the interest on the loan and not the loan capital you initially borrowed. As such, an interest-only mortgage can enable you to benefit from more affordable monthly payments than those on a repayment mortgage but you will need to repay the capital as one lump sum when the mortgage term ends.
Is an interest-only mortgage right for you? For the majority of applicants, an interest-only mortgage will not be right for them. Mortgage lenders will require a repayment strategy in place to prove how the capital will be repaid at the end of the mortgage term.
Interest-only mortgage v repayment mortgage graph
Are interest-only mortgages available for residential properties?
Interest-only lending used to be commonplace for residential properties but since the 2008 financial crisis, which was partly caused by lax lending standards, many banks started to tighten their lending criteria. Since 2008 repayment mortgages now account for over 99% of residential mortgages.
Interest-only mortgages remained in place for people wanting to purchase a buy-to-let investment property but customers wanting a home to live in found it difficult to get a mortgage on an interest-only basis.
In recent years, interest-only mortgages have become more widely available for residential properties. But to qualify for an interest-only residential mortgage, some lenders will require you to pay a larger deposit and they might want you to show evidence of a high net income.
It may be possible to get an interest-only mortgage if you need to make a second home purchase but you may need to turn to a specialist lender. The team at YesCanDo Money can tell you which lenders offer interest-only mortgages for second-home purchases, so get in touch with our team to learn more.
Mortgage lenders often require higher deposits from customers buying a second home, so you will usually need to put down at least 20% of the value of the property. You will also need to prove to the lender that you’re able to pay for two mortgages. If you are in a financial position where you can afford these expenses, your chances of being accepted for an interest-only mortgage will be improved.
How do they compare to repayment mortgages?
With a repayment mortgage, you pay both the interest on the loan and a small part of the loan capital each month. On a repayment mortgage, your monthly payments will be higher as you are repaying some of the capital each month. You will also have peace of mind knowing that by the end of the mortgage term you will own the property outright.
With an interest-only mortgage, you only pay the interest each month. At the end of the mortgage term, you then pay back the original capital borrowed.
A repayment mortgage comes with higher monthly mortgage payments but you can have the peace of mind that your mortgage will be paid off at the end of the mortgage term.
You can benefit from lower monthly payments on an interest-only mortgage but you will pay more overall as the interest rate can be higher than that on a capital repayment mortgage.
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.
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.
To be accepted for an interest-only mortgage, you will need to pass the lender’s eligibility criteria. The same is true if you’re applying for a repayment mortgage but the criteria for interest-only mortgages are usually stricter.
The requirements set by most lenders are as follows:
Income and affordability
Considering the risks involved with interest-only mortgages, the minimum income threshold will usually be higher than that on most repayment mortgages. You will need to prove that you have enough money to afford each monthly payment and that you will be able to make the final payment on the loan.
Lenders will check your credit file after you have made your application. The higher your credit score the better but if it is low, you may be charged higher interest rates on your loan. Check your credit file with companies such as Checkmyfile UK.
The minimum age for a residential mortgage is 18 and the minimum age for a buy-to-let mortgages, is 21. Lenders will also set maximum age thresholds although some will set no caps at all. Older borrowers can benefit from Retirement Interest-Only Mortgages, so you won’t necessarily be ruled out of a mortgage if you’re approaching or in your senior years.
This applies to let buy-to-let investors as most mortgage lenders will expect you to have some kind of landlord experience before accepting you for a buy-to-let interest-only mortgage. That being said, there are specialist lenders who will loan money to first-time landlords but to access these, you should speak to a broker, such as ourselves, who can put you in touch with them.
The loan to value on a typical repayment mortgage can typically be quite high so you don’t always need a large deposit. The loan-to-value on interest-only mortgages, however, will typically be lower, so there will be a bigger deposit requirement from the lender. The lowest buy to let mortgage deposit is usually 25% of the property. For residential properties, you may have to pay as much as 50%.
You shouldn’t have much problem getting a mortgage for a bricks-and-mortar property but if it’s made from non-standard construction materials, such as a thatched country cottage or a steel-framed house, you may have a little more trouble. You might also have trouble getting a mortgage if you’re looking to move into a non-traditional house, such as a listed building or a high-rise flat. This isn’t to say getting a mortgage is impossible for these property types but you may need to turn to a specialist lender.
As mentioned, you will need to have a solid repayment plan in place to make the final payment at the end of the mortgage term.
Each lender will have their own requirement for which type of repayment plans they consider acceptable. To improve your chances of a successful mortgage application, it’s wise to use the services of a mortgage broker who will match you with a lender that can accommodate your particular plan.
Acceptable repayment vehicles
The type of repayment plan that can be considered ‘acceptable’ will vary between lenders but generally speaking, the following are some of the methods that can be used to repay the loan capital at the end of the mortgage term.
Sell the property
This is a popular repayment plan for buy-to-let landlords but buyers looking for residential mortgages can also choose to sell their property if they have enough equity to pay off the remaining balance at the end of the mortgage term.
If you get to the end of the term and you aren’t able to pay all the capital, you might need to sell the property anyway. However, you can sometimes avoid this if you’re eligible for a new loan or an extension.
Sale of other assets
Buy-to-let investors can use other properties within their portfolio to repay the loan at the end of the mortgage term while residential customers could use the sale of another high-value asset, such as a piece of artwork or jewellery, as their repayment vehicle.
A number of investment types can be considered acceptable for raising money for the final payment on the mortgage loan. These can include stocks and shares, ISAs, bonds, and unit trusts. As such investments are subject to fluctuation, some lenders will have strict criteria on the investment types that can be used.
Cash repayment or pension lump sum
You could use your savings to make a cash repayment or any money you have been given as an inheritance. The tax-free lump sum from your pension pot could also be used at the end of the term.
Retirement interest-only mortgages (RIO)
Retirement interest-only mortgages have no fixed end date so the loan will be repaid from the property sale if you move into care or after you pass away. It’s possible to remortgage to this type of product when you’re of the appropriate age so speak to our team if you would like to explore this option.
If you are aged 55 or over, you can remortgage onto an equity release product, such as a lifetime mortgage. This can be used as a repayment vehicle but it’s wise to take advice from a mortgage broker before considering this option.
It’s possible to remortgage from an interest-only mortgage to another mortgage product, such as a repayment mortgage or a part and part mortgage (combination of repayment and interest-only) if your repayment strategy fails to deliver at the end of the term. Your existing lender might also agree to extend your mortgage if your circumstances allow for this possibility.
How to get an interest-only mortgage
It’s possible to get an interest-only mortgage for a buy-to-let or residential property by approaching a lender directly but if you’re hoping to gain access to one of the most competitive deals on the market (which of course you will be), it’s worth speaking to a mortgage broker such as ourselves. We have access to every interest-only lender on the mortgage market so we will search lenders on your behalf to make sure you get an interest-only deal with lower monthly payments.
Which lenders offer these mortgages?
An increasing number of lenders are now re-introducing interest-only mortgages again although some have strict criteria around minimum income and deposit requirements. Some are a little more flexible, however, so speak to our team about the mortgage provider that is right for your particular set of circumstances.
Below are some examples of lenders willing to offer an interest-only mortgage to customers who qualify for their deals.
|Lender||Minimum Income (Single)||Minimum income (Joint)||Deposit||Minimum Equity||Important|
|Barclays||£75,000||£100,000||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|
|Santander||N/A||N/A||50%||On application||Max age 70|
|Natwest||£75,000||£100,000||25%||On application||mortgages £25,000+ term must finish by age 70|
What rates to expect
Interest-only mortgages are available at both variable and fixed-term rates, with the latter being the most favourable option at the moment due to the increasing rise in interest rates. The interest charged will depend on a number of factors, such as the type of loan you take out, the size of your deposit, and the total length and amount of your loan.
Example: Interest-only vs repayment mortgage
On a £250,000 interest-only mortgage with a 5% interest rate over a 25 years term, your monthly payments would be £1041.67 a month, which totals to £312,501 over the 25 year term. You would also however have to pay back the £250,000 when the mortgage deal ends.
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 monthly 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.
YesCanDo – Interest-only mortgage specialist
If you would like to know more about how interest-only mortgages work, get in touch with our expert team. We will explain the key differences between an interest-only mortgage and a repayment mortgage and will explore the best options for you.
Should you decide to apply for an interest-only mortgage, we will compare mortgage offers and help you secure the best rates to ensure a reduction in your monthly mortgage payments.
Speak to an Interest-Only Expert Advisor
FAQs about Interest Only Mortgages
You may be allowed to pay off your loan early during the interest-only mortgage term but as with a repayment mortgage, you may have to pay your existing mortgage provider an early repayment charge.
Protection policies can help you make the repayments on your mortgage in the event of sickness, disability, or the death of one person in a joint mortgage. These can be taken out with either an interest-only or repayment mortgage.
Insurance types include:
Critical illness cover
Mortgage protection insurance
Speak to a member of our team to learn more.