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Interest only mortgages

If you want to buy a property but keep your monthly payments low, an interest only mortgage could be right for you. Compare mortgages with us to find a deal that could best suit your needs. 

If you want to buy a property but keep your monthly payments low, an interest only mortgage could be right for you. Compare mortgages with us to find a deal that could best suit your needs. 

Tobi Owens
From the Mortgages team
3
minute read
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Posted 5 OCTOBER 2020

What is an interest only mortgage?

With an interest only mortgage, you only pay back the interest on the money you’ve borrowed each month. At the end of the mortgage term, you’ll still owe exactly what you borrowed, so you’ll have to find a way to pay off this amount. Banks don’t want to put people in a position where they can’t pay back the money they owe, so interest-only mortgages aren’t as common as standard repayment mortgages. 

What’s the difference between interest only and repayment mortgages? 

With a repayment mortgage, you’re paying off the interest on the loan, as well as a chunk of the amount borrowed. This will make your monthly payments higher, but will also mean you should eventually pay off the loan in full. 

Let’s say you borrow £160,000 on a repayment basis, over 25 years, at an interest rate of 3%.

Assuming the interest rate stays the same, your monthly repayments will be £759.

The total you’d pay over the full term would amount to £227,583 (£160,000 mortgage debt + £67,583 total interest). 

With interest-only mortgages, you’re only paying off the interest. That means you’ll pay less each month. But you’ll still have to pay off the full cost of the property at the end of the loan term. 

For example, if you borrow £160,000 on an interest-only basis over 25 years, at an interest rate of 3%, your monthly repayments will be just £400 (assuming the interest rate stays the same).

However, the total amount you’ll pay over the full term will be £279,937 (£160,000 mortgage debt + £119,937 total interest).

So, although your monthly repayments will be much lower, you’re effectively paying more in total than you would on a repayment basis.  

Also bear in mind that once you’ve reached the end of your repayment mortgage term, you won’t owe anything and you’ll own the property outright. With an interest-only mortgage, you’ll still have to pay back the full amount you borrowed. In the case of the above example, £160,000 of debt is still outstanding.

Can I get an interest only mortgage?

Whether or not you’re approved for a mortgage is at the lender’s discretion. But some things will make you a more desirable applicant. For example:  

  •  If you have a large deposit  or have already built up equity in another property.  
  • If you have a substantial annual income. If you’re a high earner, this could reassure the bank that you can pay off the final sum. 

You’ll also need a workable plan in place to repay what you owe when the mortgage ends.

Repayment plans

To qualify for an interest-only mortgage, you’ll need to prove to your lender that you have a solid repayment plan. This could come in the form of investments like ISAs, or you might have cash in savings or endowment policies.

Alternatively, you could sell a second property, if you have one. But property values go down as well as up, so it’s not something you can rely on.

Different lenders will have different criteria. You’ll need to check that your plan meets your lender’s approval.

Be warned, your lender may regularly check that your repayment plan is still in place. This means that spending your savings once the mortgage is approved, for example, would probably be a bad idea.

How much do I have to earn to get an interest-only mortgage?

The total amount you can borrow will typically be a multiple of how much you earn. But getting an interest-only mortgage can depend on lots of factors, not just earnings. These can include the price of the property, how much you want to borrow, your individual circumstances and the lender’s criteria.  

Can I make a joint application for an interest only mortgage?

Yes. But you may well find you need a higher joint income to qualify, than if you were applying on your own. However, it might be easier to reach that threshold if you and your partner earn roughly equal salaries.  

How big a deposit will I need for an interest only mortgage?

This will vary depending on the lender. But to qualify for an interest-only mortgage, you’ll likely need a higher deposit than you would for a repayment mortgage, as banks consider them riskier.  

What are the advantages of an interest only mortgage?

  • Interest only mortgages typically have lower monthly payments than repayment mortgages. 
  • You can invest these savings in your home and potentially increase its value. 
  • If you’re after a buy-to-let mortgage, it’s worth knowing that many buy-to-let landlords opt for interest-only mortgages, then put any profit from rent towards the capital amount.

What are the disadvantages of an interest only mortgage?

  • It can cost you more in the long run. With an interest-only mortgage, you pay interest on the entire amount for the whole term. Repayment mortgages allow you to chip away at the money owed, which means the amount of interest you pay should decrease over time.   
  • There’s no certainty. If the property is an investment, there’s no guarantee it’ll be worth enough to pay off the balance and settle the mortgage. You’ll need a plan to pay off the balance at the end of the term. 
  • The banks deem interest-only mortgages risky. That’s why many have stopped offering them. They may insist you save in a long-term ISA or stock market-linked account, to pay off the mortgage at the end of the term.  

Always seek expert financial advice if you’re considering taking an interest-only mortgage.  

What should I consider if I have an interest only mortgage?

There are a few things to think about if you already have an interest-only mortgage:  

  • Can I switch to a repayment mortgage?  
    If your circumstances change it could make sense to switch to a repayment mortgage. If that’s the case, you’ll probably want to look into remortgaging.  
  • Should I pay into an investment plan?  
    Investing in stocks, shares or other financial products could be a good strategy for repaying your loan. But there are many products out there and some are riskier than others. Talk to an independent financial advisor before you make any decisions.  
  • Is it a good idea to make lump-sum repayments? 
    If you suddenly come into money – you get an inheritance, for example - it could be a good idea to make a lump-sum payment on your mortgage. However, some lenders may penalise you for doing this, so check any early repayment charges first.  
  • What are my remortgage options? 
    You could look for another interest-only mortgage. Or if you want to switch to a repayment mortgage, it’s usually fairly straightforward. Interest-only mortgages will come with an initial rate, often lasting between two and 10 years. After this, if you don’t remortgage, you’ll be put onto the lender’s standard variable rate, which is likely to be uncompetitive. It’s a good idea to take a look at what’s available before your deal comes to an end. 

Can I get an interest-only mortgage with bad credit?

It’s possible to get an interest only mortgage with  bad credit, but it’s not easy in today’s anti-risk lending environment. 

A part and part mortgage is a halfway house between an interest-only mortgage and a capital repayment mortgage. This can bring down your monthly repayments while making sure some of the balance is paid off, which means you’ll have less to repay at the end. If you have a poor credit record, a part and part mortgage may be easier to get. But please note, we don’t compare this type of mortgage at Compare the Market. 

What happens at the end of an interest only mortgage?

If your repayment plan has stayed on track, you should already have enough money to pay off the outstanding mortgage at the end of its term.

This could be in the form of investment funds, for example:

  • A high-interest savings account or ISA
  • Stocks and shares
  • Investment bonds
  • A pension fund
  • A unit trust

If your savings or investment funds aren’t enough to cover the mortgage debt, don’t panic. There are things you could try:

  • Talk to your lender to see if they’ll let you extend the term of your loan. This will give you more time to get the money together to pay off the outstanding balance.
  • If you’re a landlord with a portfolio of properties, you could use the equity in your other properties to pay off the outstanding balance.
  • If you’re on a high rate mortgage, you could look into the possibility of remortgaging. You may be able to find a cheaper rate repayment mortgage to switch to.

The final option would be to sell your property. If you’ve been paying interest only on it for the past 25 years, with any luck your home will have increased significantly in value. Once you’ve paid back the mortgage debt, you may find you’re left with a sizeable sum to put towards a new home.

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