What is an Interest Only Mortgage?
With an interest only mortgage, you only pay off the mortgage interest each month, and none of the original loan – that must be paid back at the end. This can make a mortgage on an interest only basis worth considering if you need to keep your monthly mortgage repayments low.
An interest only mortgage can be worth exploring if you need to keep your monthly mortgage repayments low. That’s because your payments only cover the interest you’re being charged, and not any of the original loan you take out. However, you will need a plan for paying the loan amount back at the end of your mortgage term.
Read on to learn more about what an interest only mortgage involves and how to get one.
How interest only mortgages work
Take out any type of mortgage, and you will need to pay interest on the amount you borrow.
Most mortgages today are repayment mortgages, meaning your monthly repayment covers both the interest you are charged and some of the lump sum you borrow. Here, if you make all the payments you should, everything – both the interest and your loan amount – will be paid off in full by the end of your mortgage.
The difference with an interest-only mortgage is that your monthly repayments are not paying back any of the capital you’ve borrowed. So if you take out an interest only mortgage for £100,000, you will still owe £100,000 at the end of your mortgage term. This is because your repayments are only enough to clear the interest on the loan.
As a result, your monthly mortgage repayments should be lower than if you were to take out a standard repayment mortgage. But because you’re always paying interest on the full loan amount (as it’s never being paid down), you’ll usually pay more in interest over the lifetime of an interest only mortgage overall.
Once the mortgage term is over, you will also need a way to pay back the full sum you’ve borrowed.
Can you still get interest only mortgages?
It is still possible to get an interest only mortgage to buy a residential property, but they are not as widely available as they once were. Some lenders offer retirement interest only, or RIO mortgages, to older borrowers who can’t pay off their existing mortgage or want to release some of the equity in their home.
The best way to find lenders offering interest only mortgages is through our mortgage comparison tool. Interest only mortgages can come with either fixed or variable rates.
» COMPARE: Interest-only mortgages
Alternatively, if you’re a landlord wanting to borrow to buy a rental property, the majority of buy-to-let mortgages are offered on an interest only basis.
» COMPARE: Buy-to-let mortgages
How to pay off an interest only mortgage
Lenders want you to have a plan for how you intend to repay your mortgage loan before they will offer you an interest only mortgage. Requirements vary between different lenders, but an acceptable repayment plan might include savings, investments, an endowment policy, a pension lump sum, or owning another property that you could potentially sell. However, savings are becoming less accepted by lenders.
Relying on a potential windfall such as an inheritance, or hoping property values rise so you can downsize to release the equity you’ve built up, are not usually considered viable repayment plans.
What are my options if I can’t pay back my interest only mortgage?
If you have an interest only mortgage and are concerned that you won’t be able to repay your loan, you should talk to your lender or a financial adviser straight away.
Some of the options you might have include:
- extending your mortgage term, so you have extra time to find the funds you need
- arranging a remortgage to a different interest only deal, again to give you more time (you may also find a better deal)
- switching over to a repayment mortgage so that you’ll start to make progress in repaying your loan
- selling the property on which you have the interest only mortgage in the hope of raising enough to cover what you owe
While most lenders will want to find a suitable way forward, your other assets could be at risk, or your home might be repossessed, if a solution can’t be found.
What do you need to get an interest only mortgage?
If you’re thinking of applying for an interest only mortgage, you’ll generally need:
- a deposit of at least 25% (but it could be as high as 40%)
- an annual income high enough to make the mortgage affordable for you and minimum income levels vary from each lender
- a plan for repaying your mortgage that your lender deems acceptable
While having a good credit score can also help secure a mortgage, talking to a specialist lender may be worthwhile if you have bad credit and want an interest only mortgage.
» COMPARE: Bad credit mortgages
Jim brings together unique data insights, contextual knowledge and thought provoking themes, to shed new light on important issues affecting both UK businesses and individuals. Read more
Tim draws on 20 years’ experience at Moneyfacts, Virgin Money and Future to pen articles that always put consumers’ interests first. He has particular expertise in mortgages, pensions and savings. Read more