What is an Interest Only Mortgage?
Interest-only mortgages require monthly payments of the interest owed, with the capital amount you’ve borrowed paid at the end of the mortgage term. Once your interest only mortgage ends, you will be required to pay off the capital amount as a lump sum of money.
This guide focuses on interest only mortgages for residential property. If you are looking to purchase a buy to let property then visit our guide that will discuss repayment strategies for buy to let in more detail.
How do interest-only mortgages work?
Monthly payments are lower for interest only mortgages than for repayment mortgages because the amount borrowed is not being paid back each month. It is important to regularly check that your repayment plan is on track.
How to apply for an interest only mortgage
You can apply for an interest-only mortgage directly with a lender or with a mortgage broker.
Some interest only mortgage deals are available through a mortgage broker only because certain lenders insist on using an intermediary.
How Much Will My Interest Only Mortgage Cost?
Interest only mortgages are an option if you are looking to minimize your monthly mortgage payments. You will, however, still need to pay off your full mortgage amount at the end of your mortgage term, so it is important you have a good plan in place to be able to afford this.
If you are considering an interest only mortgage, this mortgage calculator will work out how much the monthly interest payments are likely to cost you. Compare it to how much a repayment mortgage will cost you using our repayment mortgage calculator and ensure you read our guide about interest only mortgages before you make a final decision.
Retirement interest-only mortgages (RIOs)
A number of lenders are offering interest-only mortgages that are designed for people who are retired or who are nearing retirement. These are sometimes referred to as ‘RIO mortgages’.
RIO mortgages are an option for retired people who need to release cash from their property as an alternative to taking an equity release product.
Interest Only and Repayment Mortgages Compared
As you are only paying the interest each month, interest only mortgages have lower monthly payments than those of repayment mortgages. With a repayment mortgage, you will pay back the interest as well as a small part of the capital amount borrowed each month.
With lower monthly payments, interest only mortgages are more affordable in the short term, keeping your monthly outgoings to a minimum. However, you must have a suitable plan to be able to pay the capital owed at the end of the term and lenders will want you to prove you have an adequate repayment plan in place.
With a repayment mortgage, your monthly repayments will be higher but at the end of the term, if you have made all of your monthly repayments, you will owe the lender nothing and own the property outright.
You can find out more about the different types of mortgages here which are applicable to both interest only and also repayment.
Use our handy calculators to compare what your monthly payments will be for an interest only mortgage and for repayment mortgage options.
History of interest only mortgages
Interest only mortgages were popular during the 1990s as they were seen as an easy way to get into the property market. They accounted for a third of all mortgages just before the financial crisis of 2008. Before the financial crisis, borrowers were often able to secure interest only mortgages without showing solid evidence to the lenders of how the capital would eventually be repaid.
Up until recently, it was common practice for borrowers to take an endowment mortgage which was an interest only mortgage with an endowment policy used as the repayment method. But due to investment under performance, many endowment policies did not generate enough capital to repay the outstanding mortgage amount and those property owners are now seeking alternative ways (such as those outlined below) to repay their interest only mortgage.
It soon became clear that scores of interest only customers would be unable to pay off their mortgages and as a result, it is now much harder to obtain an interest only mortgage with lenders requiring larger deposits and approved repayment plans. According to a recent article in The Telegraph, more than 100,000 interest only mortgages will mature this year, still leaving 1.5 million outstanding.
Ways to repay an interest only mortgage
If you are are looking into taking out an interest only mortgage, acceptable repayment plans might include:
- Pension lump sums – a quarter of a pension’s value can be taken tax free
- The sale of other assets such as second properties
- Investment policies (ISAs, stock market investments and endowment policies)
- Downsizing to a less expensive property at the end of the term
Lenders all have varying criteria and they may make occasional checks throughout the mortgage’s term to ensure that your repayment plan is still in place and on track to enable you to make the final payment.
With so many variables and because everyone’s situation is different, it is vital you get individual advice before you decide to take out an interest only mortgage. Speak to one of our advisers and we can help with your decision making process.
If you already have an interest only mortgage and are looking into how you will repay the capital at the end of its term, options might include:
- Downsizing your home by selling your property and buying a cheaper one so that you can use the proceeds from the sale to pay off the mortgage balance. See and read our useful house value guide now.
- Lump sum overpayments at either regular or periodic times. Check our overpayment calculator to see whether this could be viable for you
- Switching all or part of your balance to a repayment mortgage basis
- Remortgaging to a better mortgage rate in order to free up money for investing or overpaying. Read our guide to remortgaging for further information.
- Paying into an investment plan which can be used to pay off the capital at the end of the term.
The list above is not exhaustive so it is important to seek personal advice for your own situation. If you are aware of a potential shortfall in funds to repay your mortgage balance then it is imperative that you look for a solution sooner rather than later.
What are the pros and cons of an interest only mortgage?
- It usually has low monthly payments.
- Low monthly payments enable the homeowner to use the extra money to improve their property and increase its value.
- It can be a good option for landlords with a buy-to-let mortgage. They can put rental income towards paying off the capital.
- It costs more overall.
- There is uncertainty with regards to paying off the balance at the end. You’ll need to have a sound plan that stands the test of time.
- Some lenders consider them to be risky and don’t offer them at all.
- Lenders may insist on you saving to pay off the mortgage, using a long-term ISA.
Frequently Asked Questions
With an interest only mortgage, your monthly repayments will be lower because they don’t include paying back any of the capital borrowed. The loan will still need to be paid back at the end of the mortgage term however, which makes interest only mortgages only suitable for those with a lot of equity and a solid repayment plan in place to pay the capital lump sum back.
Interest only mortgages were widespread in the UK until the 2008 financial crash, after which many lenders withdrew their deals. There is, however, an increasing number of lenders returning to interest only lending, now with stricter lending criteria.
Speak to a mortgage adviser for up to date advice about current interest only lenders and deals.
They are available to borrowers wanting a residential or buy to let mortgage but due to the strict lending criteria, interest only mortgages are not usually suitable for first-time buyers.
Interest only mortgages are available to buyers who have a large deposit as lenders typically only lend up to 50% of the property value,
Some lenders will also only lend on an interest only basis to individuals or couples with a total annual income of £100,000 or more.
They are more widely available to landlords wanting a buy-to-let interest only mortgage than to residential buyers.
Interest only mortgages require monthly payments of the interest owed, with the capital amount you’ve borrowed paid at the end of the mortgage term. Once your interest only mortgage ends, you will be required to pay off the capital amount as a lump sum of money.
This guide focuses on interest only mortgages for residential property. If you are looking to purchase a buy to let property then read our guide that will discuss repayment strategies for buy to let in more detail.