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Interest-only mortgage
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What are interest-only mortgages?
With an interest-only mortgage, you only repay the interest charged on your loan each month, rather than any of the actual loan. This means that at the end of the mortgage term, you'll still owe the total amount you borrowed (capital).
Interest-only mortgages have lower monthly payments than capital repayment mortgages, but you'll pay more interest overall, as it's charged on the full loan amount each month, for the whole mortgage term.
Interest-only mortgages are most often used for Buy-to-let properties. Some lenders offer them for residential purchases, but they're usually only available to higher-income earners with a large deposit.
| Interest-only mortgage | Repayment mortgage |
|---|---|
| You pay off just the interest each month | You pay off the interest and some capital each month |
| Lower monthly repayments | Higher monthly repayments |
| Interest is charged on the entire loan balance every month | Interest charges reduce as your loan balance does |
| At the end of the mortgage term you still owe what you originally borrowed | At the end of the mortgage you owe nothing and own the property outright |
How to get the best interest-only mortgage rates
To get the best interest-only mortgage rates you'll need a good credit score and a low LTV (loan to value) - which means you'll need a big deposit, 25% is the usual minimum requirement.
It's also worth considering that even the very best interest-only mortgages typically have higher rates than equivalent capital repayment mortgages, as there's more risk to the lender in this type of lending.
How much deposit will I need for an interest-only mortgage?
Generally, you'll need a larger deposit of at least 25% for an interest-only mortgage, but some lenders may ask for 40% or more, depending on your circumstances and the property type.
This is because they are taking more risk, as there's no guarantee that your chosen repayment strategy will cover the full lump sum payment at the end of the mortgage term.
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Can I get an interest-only residential mortgage?
Most lenders offer interest-only mortgages for investment purchases, but if you’re looking at interest-only residential mortgages it will be much more difficult to find one.
Those lenders that do offer interest-only mortgages for this purpose have fairly strict criteria:
A larger deposit - the best interest-only mortgage rates are available to those offering 40% deposit or more
Usually a higher minimum income requirement - £50,000 - £75,000 for single applicants and £100,000 for joint applicants are typical minimum thresholds
Often a lower LTV (loan to value) than a repayment mortgage, usually 75% LTV is the highest available
As a first-time buyer, interest-only mortgage options are likely to be limited unless you're a high income earner with a large deposit.
Can I get an interest-only remortgage?
It can be easier to remortgage onto an interest-only deal than it is to get an interest-only purchase mortgage. This is because when you hold equity in your home, the risk to the lender is reduced.
If you've paid down a chunk of your mortgage, and particularly if your property has also risen in value, an interest-only remortgage could save you money on your monthly payments, especially while interest rates are high. However, keep in mind that you'll pay more interest overall this way.
What repayment strategies can I follow?
The lender will need to know how you'll repay the capital at the end of an interest-only mortgage - which they may refer to as your repayment plan, repayment vehicle or repayment strategy. Each has their own accepted methods and some accept a mixture of the following:
1. Cash repayment
If you have enough in savings, an inheritance, buy-to-let income – or if an investment has matured enough to pay off the mortgage, you can pay back the loan in full with a cash repayment
2. Switching to a repayment mortgage
It may be possible to switch your mortgage to a capital repayment plan at the end of the original term, however, the term offered could be fairly short - depending on your age. A shorter term could make the affordability criteria tight. Also keep in mind that you'd be paying interest twice on the same property.
3. Sell your property
Landlords often opt to sell the property at the end of the mortgage term. Most properties will have gained value over the duration of a full mortgage term (average of 30-35 years). You may also be able to downsize to a smaller home using some of the proceeds of the sale, if your profits are large enough.
Can the Mortgage Charter help me get an interest-only mortgage?
In June 2023 The Mortgage Charter was drawn up to tackle the issues caused by a rapid rise in interest rates across the mortgage market, after a long succession of increases in the Bank of England base rate.
The charter lays out a few easements that lenders have agreed to, to help those struggling to afford their current mortgage repayments and/or struggling to find an affordable remortgage option.
One of the easements is that customers struggling to manage their mortgage repayments can temporarily switch to interest-only repayments, without any affordability or credit checks, for a period of six months.
While this may offer financial breathing space for some, it's important to understand that to switch permanently to an interest-only mortgage, you'd need to meet the lenders' standard criteria - including affordability and credit checks.
What happens if I can't repay the loan at the end of the mortgage?
If you can’t cover the whole final repayment amount, it may be possible to extend the term in some cases. However lenders will want evidence that the extension period provides you adequate opportunity to repay the outstanding balance.
If your're completely unable to repay the loan, and don't qualify for a remortgage or term extension, you would need to sell your home to cover the final payment. Your other assets may also be at risk, if the sale doesn't cover the whole lump sum.
How to minimise the risk of this happening
A good strategy with an interest-only mortgage is to make regular overpayments wherever affordable. This will reduce your balance, leaving less to repay at the end of the term. Always check applicable early repayment charges (ERCS), as overpayments above 10% of your balance sometimes trigger these.
A part and part mortgage (part interest-only, part repayment) is another good way to reduce the loan balance before it becomes payable, especially if your term is nearing the end and you don't think you'll have enough to repay the full loan.
Over 55s could also consider a retirement interest-only mortgage, which has no fixed end date. Therefore you won't have to repay the loan balance until you pass away or move into long-term care.
Advantages and disadvantages of interest only mortgages
Your monthly repayments are lower than with a repayment mortgage
You might be able to afford a more expensive property due to lower monthly costs
Useful when investing in buy-to-let properties to keep business costs down
Investments or buy-to-let income could surpass the value of mortgage debt allowing you to repay your mortgage and make a profit
You still owe the whole amount you borrowed at the end of the term
An investment you’re paying into might not grow enough to pay off the mortgage
Selling your home may not give you enough to repay the loan if house prices fall
You'll pay more interest overall than with a repayment mortgage
Lenders require a larger deposit (usually 25% or more)
There's a higher risk of negative equity than with a repayment mortgage as you're not reducing the loan, so rely entirely on a rise in property prices to gain equity
Interest-only mortgages can be beneficial for property investors, or those expecting an inheritance or similar delayed income - as they keep monthly costs low. However, it can be riskier and cost much more than a capital repayment mortgage, so always check with an experienced broker.”Kellie Steed, Mortgage Content Writer
Interest-only mortgages FAQs
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE
Uswitch is not a mortgage intermediary and makes introductions to Mojo Mortgages to provide mortgage solutions. Uswitch and Mojo Mortgages are part of the same group of companies. Uswitch Limited is authorised and regulated by the Financial Conduct Authority (FCA) under firm reference number 312850. You can check this on the Financial Services Register by visiting the FCA website. Uswitch Limited is registered in England and Wales (Company No 03612689) The Cooperage, 5 Copper Row, London SE1 2LH. Mojo Mortgages is a trading style of Life's Great Limited which is registered in England and Wales (06246376). Mojo are authorised and regulated by the Financial Conduct Authority and are on the Financial Services Register (478215) Mojo’s registered office is The Cooperage, 5 Copper Row, London, SE1 2LH, and head office is WeWork No. 1 Spinningfields, Quay Street, Manchester, M3 3JE. To contact Mojo by phone, please call 0333 123 0012.
Last updated: 11 September 2023