Interest-only vs repayment mortgage

What is a repayment mortgage?

With a capital repayment mortgage, you’ll make monthly repayments for an agreed period of time (also known as the ‘term’) until you’ve paid back both the capital and the interest.

This means that the amount you owe will decrease every month. And, as long as you keep up the repayments, your mortgage will be fully paid off at the end of the term. Having a fully paid off mortgage means you own your own home.

Advantages of a repayment mortgage

• You may end up paying less interest overall because what you owe decreases every month. Later in your mortgage term, more of each payment goes towards clearing your balance, and less towards interest.
• As you pay off your mortgage, you may be eligible for lower interest rates as your outstanding loan has reduced.
• The security of owning your own home at the end of the mortgage term (if you make all of your repayments).

Disadvantages of a repayment mortgage

• Your monthly payments will be higher than if you were to choose an interest-only mortgage. You can use an online mortgage calculator to work out how much your monthly payments are likely to be.

What is an interest-only mortgage?

With an interest-only mortgage, your monthly payments only pay off the interest charges on your loan, not any of the capital borrowed.

This means that your payments will be less than on a repayment mortgage. But at the end of the term, you’ll still owe the original amount you borrowed from the lender.

To fully own your property by the end of the mortgage term, you will need to repay the whole balance by:

• Using a repayment vehicle (an investment you have running alongside your mortgage), including any type of savings plan (for example, an ISA, investment fund or pension lump sum).
• Using a lump sum that you receive before the mortgage ends.

It’s important to note that most mortgage lenders will ask how you intend to repay your loan – and not all lenders will accept all repayment strategies (for example, inheritance). 

Each lender will have their own criteria, which is why it’s important to speak to a mortgage expert to discuss your options.

Advantages of an interest-only mortgage

• Lower monthly payments, as you are only paying back the interest on your loan.
• Greater control over your investments, meaning you can decide how you save to repay the capital of your mortgage.

Disadvantages of an interest-only mortgage

• As the capital you owe isn’t shrinking, you may have to continue paying interest on the full amount.
• At the end of the mortgage term, you will still owe the lender the initial amount you borrowed. So, while you may be enjoying smaller monthly repayments, you’ll need a plan in place for how you will pay back the capital.
• There is a higher amount of risk if your repayment vehicle performs badly.

Can I change my interest-only mortgage to a repayment mortgage?

Yes, as long as your mortgage lender approves you for a repayment mortgage. Lenders carry out an approval process as you will typically be moving to much higher monthly repayments. Options for switching to a repayment mortgage from an interest-only mortgage may include:

• Switching to a repayment mortgage with your current lender to keep the same term and interest rate.
• Switching to a new repayment mortgage with your current lender.
• Remortgaging onto a repayment mortgage with a different mortgage lender.
• Switching to a part and part mortgage, where you make repayments on a proportion of the outstanding balance (with either your current lender or a new one).

The process of switching can vary from lender to lender and differs depending on whether you’re carrying out a product transfer with your existing mortgage provider, or a full remortgage with a new one.

Many borrowers treat this process as an opportunity to search the market for a better interest rate, which is something a reputable mortgage broker can help you with.