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- How does a repayment mortgage work?
- How does an interest only mortgage work?
- Repayment mortgage pros and cons
- Interest only mortgage pros and cons
- Interest only mortgages vs repayment mortgages
- Is an interest only or repayment mortgage best for me?
- Part and part mortgages
- Can I switch between a repayment and an interest only mortgage?
As a homebuyer, you need to know the difference between an interest only mortgage and a repayment mortgage. Here’s how each one works, and their pros and cons, to help you decide whether an interest only or repayment mortgage is the best option for you.
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How does a repayment mortgage work?
With a repayment mortgage, once you make that final monthly payment, the mortgage should have been repaid in its entirety, and you’ll fully own your property.
This is because the payment you make each month pays off the interest on your mortgage and some of the initial amount, or capital, you borrowed. These mortgages are also often called capital repayment mortgages as a result.
» MORE: All about repayment mortgages
How does an interest only mortgage work?
With an interest only mortgage, the amount you pay each month only covers the interest charged on your loan.
Like a repayment mortgage, you’ll make monthly repayments over a specific mortgage term. However, when you reach the end of the term, you will still have the original sum you borrowed to pay off because this hasn’t been gradually repaid each month.
When applying for an interest only mortgage, lenders usually want to know how you intend to pay it back. Acceptable repayment strategies may include investments, pensions or savings. If you can’t pay back what is owed, then you may have to sell your property.
» MORE: Interest only mortgages explained
Repayment mortgage pros and cons
There are advantages and disadvantages to repayment mortgages.
Advantages of repayment mortgages
- You should own your home outright at the end of the mortgage term if you’ve made all of your monthly repayments.
- You could pay less in interest overall compared with an interest only mortgage because the sum you pay interest on will get smaller over time as you pay it off.
- As the amount you owe decreases, it may be possible to get a better mortgage deal at a lower loan-to-value (LTV).
Disadvantages of repayment mortgages
- Your monthly repayments will be higher than on an equivalent interest only mortgage.
- It can take a while for your original loan amount to start dropping notably.
Interest only mortgage pros and cons
There are advantages and disadvantages to interest only mortgages.
Advantages of interest only mortgages
- Your monthly repayments will be lower than on an equivalent repayment mortgage.
- It may be possible to borrow more and afford a more expensive home.
- The money saved on repayments could be used to pay for home improvements or for another purpose.
Disadvantages of interest only mortgages
- You will need to repay the original mortgage amount back at the end.
- The total interest you pay overall is likely to be higher than with a repayment mortgage, because it’s always charged on the original loan amount.
- You will need a repayment strategy, so may need to contribute to an investment or savings plan, and keep track of how it’s performing.
- If your repayment plan comes up short, you may have to sell your home to cover the outstanding mortgage balance.
- A larger deposit and a higher income is often needed to get one.
- There are fewer interest only mortgages available than repayment mortgages.
Interest only mortgages vs repayment mortgages
The table below compares an interest only mortgage and a repayment mortgage in respect of the monthly repayments and interest payable. For a £250,000 mortgage over a 30-year term at an interest rate of 5%, monthly repayments are around £300 cheaper on an interest only mortgage compared with a repayment mortgage. However, over the entire 30-year mortgage term, an interest only mortgage borrower would end up paying almost £142,000 more in interest overall. Use our mortgage repayment calculator to see what would happen in other situations.
| Interest only mortgage | Repayment mortgage | |
|---|---|---|
| Monthly repayment | £1,042 | £1,343 |
| Total interest paid over full term | £375,271 | £233,340 |
| Total repaid over full term (interest plus original loan) | £625,271 (includes £250,000 lump sum payable at the end of the mortgage term) | £483,340 (no lump sum payable as original mortgage amount has been cleared over the term) |
Is an interest only or repayment mortgage best for me?
Borrowers often find interest only mortgages appealing because the monthly repayments are smaller than with a repayment mortgage. This is because you’re only paying off the interest on your mortgage each month.
However, with an interest only mortgage you’re also likely to pay more in interest overall, and the money you’ve borrowed still has to be repaid when the mortgage ends. Lenders will want to have an idea of how you plan to repay it before even offering you the loan on these terms ‒ this could include endowment policies, investments or even the sale of a second property. A lender may ask for updates as to whether your planned repayment strategy is on track at various times, to ensure that you don’t get to the end of the loan and have no way of paying it off.
A repayment mortgage is usually considered more straightforward in comparison. While you pay a larger sum each month, once you get to the end of your mortgage, it should be paid off in full, meaning you’ll own your property in its entirety. You’re also likely to pay less in interest overall, and have a wider choice of deals to choose from.
Most residential borrowers use repayment mortgages, whereas interest only mortgages are used more frequently by landlords for buy-to-let properties. In the case of buy-to-let, owners are more likely to view the property as an investment which they can ultimately sell to repay the loan. Whichever type of borrower you are, talking to a mortgage adviser can help you decide whether a repayment mortgage or an interest only mortgage is best for you.
» MORE: See the latest mortgage rates
Part and part mortgages
Some lenders offer part and part mortgages, or perhaps part interest only mortgages, which are effectively a combination of the two main interest only and repayment options. In this instance your monthly repayment covers the interest on your mortgage and a contribution towards paying back some of the initial loan ‒ though not enough to clear it entirely by the end of your mortgage.
As a result, a part and part mortgage will typically have smaller monthly repayments than a full repayment mortgage, but larger repayments than a standalone interest only mortgage. And there will still be some of the original mortgage to pay back at the end of the mortgage term, but not the entire amount. Lenders will want to have some idea of how you plan to do this.
Can I switch between a repayment and an interest only mortgage?
It may be possible to move from a repayment mortgage to an interest only deal, or vice versa, during the term of your mortgage, but you’ll need to get approval from your lender.
If you are moving from an interest only mortgage to a repayment mortgage, it’s important that you can prove you’re able to afford what are likely to be higher monthly repayments.
If you want to switch to an interest only mortgage from a repayment mortgage, you’ll need to have a plan for paying off the mortgage amount once you reach the end of your term.
Some lenders may allow you to temporarily switch to interest only repayments if you’re struggling to make your usual payments on a repayment mortgage.
» MORE: Best mortgage lenders
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