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Interest-only mortgages
With an interest-only mortgage, your monthly payments will only cover the interest on your loan. While this results in lower monthly payments compared to a repayment mortgage, you must repay the full capital in one lump sum at the end of the mortgage term.
Looking to compare your interest-only mortgage options? Tell us about yourself and our broker partner, Mojo Mortgages, will find the best interest-only mortgage rates for you.
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What is an interest-only mortgage?
An interest-only mortgage is a type of mortgage where your monthly payments are used to pay off only the interest charges on the amount you've borrowed, rather than any of the actual loan (known as the capital). This means that at the end of the mortgage term, you'll still owe the full amount you initially borrowed.
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. While some lenders offer them for residential purchases, they're usually only available to higher-income earners with a large deposit.
Compare interest-only vs repayment mortgages
With a standard repayment mortgage, your monthly payments cover both the interest and a portion of the capital, gradually reducing your debt over the mortgage term. In contrast, an interest-only mortgage has lower monthly payments that only cover the interest, requiring you to repay the entire capital at the end of the term.
| Interest-only mortgage | Repayment mortgage | |
|---|---|---|
| Monthly payments | Lower, as you pay off just the interest each month | Higher, as you pay off the interest and some capital each month |
| Total interest | Higher overall interest paid, as interest is charged on the entire loan balance every month | Lower overall interest paid, as interest charges reduce as your loan balance does |
| What happens at the end of the mortgage term? | 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 access the best interest-only mortgage rates, you'll generally need:
A large deposit. Most lenders require a minimum deposit of 25%, though the best rates are often reserved for those with an even lower loan-to-value ratio
A good credit score. Being able to demonstrate your reliability as a borrower will give your lender more confidence.
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.
For personalised mortgage recommendations based on your specific circumstances, get in touch with our broker partner, Mojo Mortgages. They'll compare interest-only mortgage deals and recommend options that best suit your circumstances.
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 lenders 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.
Can I get an interest-only residential mortgage?
Most lenders offer interest-only mortgages for investment purchases, but it will be much more difficult to find an interest-only residential mortgage.
Those lenders that do offer residential interest-only mortgages 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 to £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
It's worth noting that your chance of falling into negative equity is much greater with an interest-only residential mortgage, as you don't gain any equity unless your property value increases.
Can I get an interest-only remortgage?
It can be easier to remortgage onto an interest-only deal than when purchasing a property. This is because when you hold equity in your home, likely built up through any previous repayments and any increases in the home's value, the risk to the lender is reduced.
Switching to an interest-only remortgage can lower your monthly payments, but it's crucial to remember that you will pay more in total interest over the lifetime of the mortgage.
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
Can provide more flexibility for those with irregular income streams
Investments or buy-to-let income could surpass the value of mortgage debt, allowing you to repay your mortgage and make a profit
You'll likely pay more in interest over the mortgage term compared to a repayment mortgage
You're not building equity in your home through your monthly payments
As you still owe the full borrowing amount at the end of the term, there's a risk you'll be left with a shortfall if your repayment vehicle doesn't grow as expected
There's typically stricter lending criteria, such as a larger deposit requirement (usually 25% or more)
What are some repayment strategies for an interest-only mortgage?
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 lender has their own accepted methods and some accept a mixture of the following:
Cash repayment
You can pay back the loan in full using a lump sum of cash. This may come from a dedicated savings plan built up over the mortgage term, the sale of other investments or a windfall such as an inheritance. Lenders will need to see evidence that your plan is viable.
Sell your property
Landlords often opt to sell the property at the end of the mortgage term. This strategy relies on the property's value being sufficient to cover the outstanding mortgage and any associated selling costs. However, as property values can fall, there is a risk that the sale price may not be enough to clear the debt, which would result in a shortfall.
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.
Interest-only mortgages can benefit property investors as they keep monthly costs low. However, they are riskier and cost more than a capital repayment mortgage, so always check with an experienced broker whether it's suitable for your needs.”Jason McDonald, Mortgage Expert
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Interest-only mortgages FAQs
Can I switch from an interest-only to a repayment mortgage?
Yes, you can usually switch to a repayment mortgage.
In fact, lenders are likely to prefer that you pay off your loan on a repayment basis, as there is less risk involved for them. It’s harder to switch from a repayment to an interest-only mortgage, as lending criteria are stricter.
What alternatives are there to interest only mortgages?
There are two other repayment types available when you take out a mortgage, although not all lenders offer all options:
Capital repayment mortgage - where you reduce the loan and pay the interest each month
Part and part - combines elements of both repayment and interest-only methods plans, which can be a good middle ground for some people
What happens at the end of the interest only mortgage term?
At the end of an interest-only mortgage term you repay the outstanding lump sum of the loan - the full amount that you originally borrowed. Your lender approves your repayment plan at application stage and should check-in with you regularly throughout the mortgage term, to ensure you're on track to afford this.
However, maintaining the repayment vehicle is your responsibility, so it’s a good idea to monitor the progress of this at least annually. This could be by regularly checking up on relevant savings accounts and investments or by keeping an eye on local property prices. This way you can ensure your home’s value has increased if you plan to resell it to repay the loan.
Can I pay off my interest-only mortgage early?
Yes, although you should check whether early repayment charges apply, as they can amount to hundreds or even thousands of pounds. Sometimes this cancels out any saving you would have made by leaving the deal early.
Which lenders offer interest-only mortgages?
It depends what you need an interest-only for, as some lenders only offer this option for buy-to-let purchase, whereas others will consider residential use. If you're looking to use a residential interest-only mortgage, there are a few high street lenders available, as well as multiple building societies and specialist lenders.
If you're looking for a buy-to-let interest-only mortgage, you will be able to get one from most lenders that deal in buy-to-let.
It's well worth considering speaking with a mortgage broker to help you compare your options. They have in-depth lender knowledge so will be best placed to recommend providers that offer the type of mortgage you're looking for.
What is a part and part mortgage?
This is a mortgage product, not offered by all lenders, that combines elements of both an interest-only mortgage and a capital repayment mortgage.
Usually you pay some, but not all of the capital off in addition to the interest each month. This means that you'll have less to repay when the mortgage term ends, but still benefit from lower monthly repayments than with a full repayment option.
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YOUR HOME/PROPERTY MAY BE REPOSSESSED IF YOU DO NOT KEEP UP WITH YOUR MORTGAGE REPAYMENTS.
The FCA does not regulate mortgages on commercial or investment buy-to-let properties.
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