Last reviewed on 13th October 2023 by Martin Alexander (Mortgage Advisor)
If you only want to pay the interest on a mortgage each month, an interest-only mortgage could be an option. Your monthly payments will be cheaper than a repayment mortgage, but there’s still much more to consider, which we’ll explore in this guide.
What is an interest-only mortgage?
With an interest-only mortgage, you repay the interest on your mortgage rather than the capital borrowed. The remaining mortgage balance is paid at the end of your mortgage term.
A considerable advantage is that your monthly payments will be lower than a repayment mortgage. However, you’ll need a higher deposit, and you’ll have to repay the balance on your mortgage when it expires.
How are interest-only and repayment mortgages different?
The difference between interest-only and capital repayment mortgages is how the mortgage is repaid.
- Interest-only – You only pay the interest charges on the loan, so your monthly payments are lower than repayment mortgages. However, you’ll still owe the capital you borrowed, which you must repay when your mortgage expires.
- Capital repayment – You’ll repay part of the capital and interest on the loan each month. While your monthly payments will cost more, your mortgage will be paid off when your term expires.
Advantages and disadvantages of an interest-only mortgage
Before applying, it’s essential to consider the pros and cons of having an interest-only mortgage.
- Lower monthly payments – The main benefit is that your monthly payments will be lower, allowing you to manage your finances better.
- Flexible options – You can repay the capital or switch mortgage types to suit your circumstances if they change.
- Can improve cash flow – As your monthly payments will be lower, you can save more each month and boost your cash flow.
- Popular for buy to let – Many investors opt for interest-only as it allows you to make more from your investment each month.
- More expensive overall – An interest-only mortgage can appear cheaper, but you’ll pay more interest overall. This is because the capital isn’t being repaid, so the level of interest remains the same. With a repayment mortgage, you’ll pay less interest as you repay the capital borrowed.
- You’ll be left with the capital to pay off – There’s a shortfall risk, as you’ll still have the entire loan to pay off when your mortgage ends.
- Viewed as high-risk – You could lose your home if your repayment plan fails. That’s why lenders have strict criteria for interest-only for residential homes.
- You‘ll require a larger-than-average deposit – Most interest-only mortgages require a minimum 25% deposit.
What happens at the end of an interest-only mortgage?
You’ll need to repay the capital at the end of your mortgage, typically as a lump sum. Fortunately, there are several ways to do this:
- Savings – You can use savings from investments or a pension to repay the mortgage. However, it is a risk as investments aren’t guaranteed. Using your pension can also be a risk if you’re left without an income source.
- Switch to a repayment mortgage – You can switch to a repayment mortgage and start repaying the capital owed. The cost of your payments will increase, so you’ll have to assess whether it’s affordable.
- Overpayments – Your lender may allow you to make overpayments. This means you can pay towards the capital owed whenever you want. Doing so can reduce the interest you pay and clear the balance you owe.
- Sell the property – If your property has increased in value, you could sell the property to repay the mortgage. You may even have surplus income left over for a deposit on another house.
Can I get a residential mortgage on interest-only?
Some lenders offer residential mortgages on interest-only. You’ll be required to either have equity, a large deposit, high income or a repayment plan in place.
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.
Which lenders can I apply with?
- HSBC – Applicants must earn at least £75,000 to be eligible.
- TSB – Require evidence of a repayment plan before starting an application.
- Barclays – Will only allow 50% of the mortgage to be interest-only if you intend to sell the property as your repayment plan.
- Metro – Applicants must earn at least £50,000 and have a clear repayment plan.
- Pepper Money – Require applicants to have a 40% deposit to qualify.
This is just a handful of lenders that we work with, and there are other criteria that you must meet to be eligible.
What do our experts say?
If cash flow is more important to you, then an interest-only mortgage can make perfect sense. The additional money you can save monthly can allow you to buy more property. You can also use the surplus income to maintain your portfolio as a landlord.
On the other hand, if you’d rather own a property outright at the end of your mortgage term, then a capital repayment mortgage could be a better option. You’ll have an asset you own and won’t have to worry about repaying any capital. Owning a property outright can be a great source of income for retirement and will appreciate in line with inflation.
Once you’ve decided on the right mortgage type, don’t simply try to find the lowest interest rate. To calculate the best deal, you’ll need to consider criteria, fees and the overall cost of the mortgage.
About the author
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.