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Interest-only mortgages explained


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HomeMortgage Help GuidesInterest-only mortgages explained

Interest-only mortgages explained

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Last reviewed on 30th April 2022

This guide will explain whether an interest-only mortgage is suitable for you. Choosing the right mortgage type can provide many benefits while doing the opposite can prove costly. While interest-only mortgages remain popular with buy to let landlords, they are still an option for residential properties. That being said, there aren’t many lenders that offer them as it leaves little security for the homeowner.

If you’re still unsure of what to do, our experts are available to help.

What is an interest-only mortgage?

An interest-only mortgage allows you to repay just the interest on your mortgage, rather than the loan amount. The rest of the mortgage balance is then paid at the end of your mortgage term. As a result, you’ll still owe the exact mortgage you borrowed, even when your mortgage term expires.

Is this right for me?

If you’re in need of a buy to let mortgage, then an interest-only option should be straightforward.

On the other hand, if you’re applying for a residential mortgage on an interest-only option, then you’ll need to carefully plan beforehand.

To apply, you’ll need to ensure:

  • Your lender is aware you’ll be living in the home yourself
  • You have an approved repayment plan to repay the mortgage at the end of the term
  • That you’re comfortable with this arrangement
  • You have a deposit of at least 25%
  • Your income meets the requirements of your lender

It’s important to note that some lenders may require deposits of up to 40%. Furthermore, your lender may require you to have part of your mortgage on a repayment basis. This is known as a part and part mortgage, as it contains both repayment and interest-only features.

What are the advantages?

  • Low monthly mortgage payments
  • Save money each month
  • Popular for buy to let mortgages
  • Can be safe with credible repayment plans
  • Available on part interest and part repayment
  • Flexible options
  • Possibility of paying towards the capital balance

Are there any disadvantages?

  • You’re likely to pay more overall interest over the term
  • The balance of the mortgage won’t reduce
  • You’ll need a repayment plan
  • You could lose your home if your repayment plan fails
  • Most lenders don’t offer interest-only residential mortgages
  • You’ll require a larger than average deposit

How are interest-only and repayment mortgages different?

Repayment mortgages mean that you’re repaying your mortgage balance in addition to the interest on the loan. As a result, once you’ve made all of your payments, you’ll own your home outright.

In comparison, an interest-only mortgage would mean that you’d only be paying the interest on the loan. This is why you’d still owe the original mortgage balance at the end of your term.

Comparing the cost of each payment type

Interest-only mortgages can appear cheaper, especially on a monthly basis. That being said, the amount of interest will never reduce, so you will pay more overall interest when compared to a repayment mortgage.

Let’s take a look at a 25-year mortgage of £100,000 at a 3% rate:

  • A repayment mortgage will cost £474.21 a month but you’ll own the property outright after 25 years
  • An interest-only mortgage will cost £250 a month, but you’ll still owe your lender £100,000 after 25 years

From the example, interest-only is cheaper when compared to a repayment mortgage each month. That doesn’t mean to say that it’s a better mortgage to have. This is because, after 25 years you’ll still owe your lender the balance of £100,000.

Try our monthly mortgage calculator to compare the cost of each mortgage.

Are interest-only mortgages difficult to get?

Interest-only mortgages can be difficult to get, especially if the mortgage is for your own residential purposes. That being said, the majority of buy-to-let mortgages are taken on an interest-only basis.

The main reason most lenders don’t offer an interest-only option for residential mortgages is that it places homeowners in a vulnerable position. This is why the lenders that do offer them, require an adequate repayment plan to pay the mortgage when the term ends.

It was easier to get residential mortgages on interest only a few years ago, but now, the majority of residential mortgages are only available on a repayment basis. This is simply because it gives homeowners more security as failing to repay the mortgage at the end of an interest-only term can result in you losing your home.

What should I use for buy to let?

The reason that interest-only mortgages are popular for buy to let, is because landlords themselves aren’t living in the property. Furthermore, rental income is usually enough to cover the mortgage. This is another reason why landlords often choose interest-only for their buy to let mortgages.

Learn more: Interest-only buy to let mortgages explained

ask a mortgage broker

Will I need a repayment plan?

If you’re applying for a residential mortgage, then your lender will require a repayment strategy. This is so that you’re able to repay the outstanding mortgage balance when your term comes to an end. Furthermore, your lender will assess the credibility of your proposed plan.

Possible options for your repayment plan can include:

  • ISAs
  • Pensions
  • Investments
  • Savings
  • Endowment policies
  • Stocks and shares
  • Unit trusts
  • Investment bonds
  • Sale of another property

Without a repayment strategy, it will be very difficult to get a residential mortgage on an interest-only basis. Furthermore, having a plan for the end of your mortgage term is highly recommended. Failing to plan ahead is very risky and something you shouldn’t leave until the last minute.

Your lender can also check at any time if your repayment plan is still in place or if it’s changed. If your plans do change, you’ll need to inform your lender as soon as possible.

Should I switch if I have an interest-only mortgage?

It may be worthwhile to switch to a repayment mortgage. This is so you’re not left in a difficult position at the end of your mortgage term. That being said, if you have a repayment plan that’s not set to change, then you can perhaps remain on your current mortgage without any issues.

If you’re not confident with your repayment plan, then switching to a repayment mortgage can make perfect sense. This is because you’ll want to ensure each mortgage payment is paying both the interest and the mortgage balance. Doing so can also provide you with a sense of security.

You won’t be left in a difficult position at the end of your mortgage term or have the pressure of having to pay the balance, as your monthly payments will essentially do this.

Your lender may also allow you to make overpayments towards the mortgage balance, even on an interest-only mortgage. You can therefore clear the balance much sooner than waiting for the term to expire. Each lender is different so you’ll have to check whether you’ll be able to do this.

How can I find the best rates?

To find the best interest-only rates, you can use online comparison tools, but they won’t tell you if you’ll qualify for the specific deal you’re searching for. To find a deal that you’re eligible for, speak to a mortgage advisor.

A mortgage advisor can compare the deals that you qualify for and calculate the best overall mortgage. Many mortgage borrowers simply try and find the lowest interest rate, but this isn’t how to calculate the best mortgage deal.

You’ll also need to consider the term of the mortgage in addition to the fees you’ll be charged. Furthermore, some lenders may require higher deposits than others, so there’s a lot more to consider when searching for a mortgage.


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About the author

Mortgage Advisor | More Articles

Martin is a senior mortgage advisor and has held a CeMAP qualification for over 15 years while also completing an MBA in Global Banking & Finance.