Guide to interest-only mortgages vs repayment mortgages

0
Written by: YourMortgage.com
17/01/2017
Before you go looking for a mortgage or remortgage deal, you need to decide how you are going to pay off the huge sum.

Interest-only mortgages were once the norm in the UK. They have become far harder to get hold of in recent years, as lenders and regulators consider them more risky than capital-and-interest (also known as ‘repayment’) mortgages. Some lenders have withdrawn from offering interest-only arrangements except for buy-to-let mortgages (see below), while others will provide them but will ask for a large deposit or equity, often 50% or more.

How they work

With an interest-only mortgage, the payment you make to the mortgage lender each month comprises just the interest you owe them for that month. So you are not paying off any of the capital you owe.

When you take out an interest-only mortgage, you are supposed to also make a monthly payment into an Individual Savings Account, endowment or other investment. The hope is that the investment will then generate sufficient returns to pay off the capital sum you still owe at the end of the mortgage term.

However, there is no guarantee of this, so any interest-only mortgage carries an element of risk.

In the boom years of the property market, increasing numbers of first-time buyers took out interest-only mortgages, and have just paid the interest, not paying any money into an investment. With high house prices, this was the only way some people have managed to afford to buy property.

When taking out an interest-only mortgage and just paying the interest, borrowers relied on their property going up in value, being able to sell it a few years down the line for a profit, and then buying a property with a repayment mortgage.

Mortgage risks

But this approach was fraught with risk. Firstly, house prices are not guaranteed to go up. Secondly, many people sort out their mortgage and then forget about it. If you never get around to converting your interest-only mortgage to a repayment-type, and you have no investment fund building up, there is a very real risk that you may get to the end of your 25-year mortgage term still owing all of the capital initially borrowed and with no way of repaying it.

To avoid this happening going forward, most mortgage lenders now make it very difficult for borrowers to take out interest-only mortgages. They may demand a very big deposit (up to 50%) and/or ask for tangible proof that you have an investment plan in place to pay off the mortgage at the end of the term. And some have stopped accepting plans such as a future inheritance as backing for taking out an interest-only mortgage.

Repayment mortgages

With a repayment-type mortgage, the monthly repayment you make to the lender each month consists of the interest you owe plus a little bit of the capital you owe. If you keep up all the repayments on your mortgage, you are guaranteed to have paid off the mortgage at the end of the term.

Repayment-type mortgages are therefore the safest option, and are by far the most popular mortgage type in the UK.

Buy-to-let investors

Buy-to-let investors are the only borrowers who are advised to take out interest-only mortgages with no investment vehicle. That is because the rent covers your interest payments, and the long term plan is generally to sell the property in the future, and pay off the capital at that point.

There are 0 Comment(s)

If you wish to comment without signing in, click your cursor in the top box and tick the 'Sign in as a guest' box at the bottom.

Are you a first-time buyer looking for a mortgage?

Look no further, get the help you need by searching for your perfect mortgage

Five ways to get on the property ladder without the Bank of Mum and Dad

A report suggests the Bank of Mum and Dad is running low on funds. Fortunately, there are other options for st...

The essential Your Money guide to the April 2018 tax changes

As we head into the 2018/19 tax year, a number of key changes take place to existing policies while some new i...

A guide to switching energy provider

All you need to know about switching from one energy supplier to another.

What will happen if rates change

How your finances will be impacted by a rise in interest rates.

Regular Savings Calculator

Small regular contributions can build up nicely over time.

Online Savings Calculator

Work out how your online savings can build over time.

Having a baby and your finances: seven top tips

We’re guessing the Duchess of Cambridge won’t be fretting about maternity pay or whether she’ll still be...

Protecting family wealth: 10 tips for cutting inheritance tax

Inheritance tax - sometimes known as 'death tax' - can cause even more heartache for bereaved families. But th...

Travel insurance: Five tips to ensure a successful claim

Ahead of your summer holiday, it’s important to make sure you have the right level of travel cover or you co...

YourMoney.com Awards 2018

Now in their 21st year, our awards recognise the companies offering the best products and services to consumers

Money Tips of the Week

Read previous post:
shutterstock_557324815
How to slash £160 off your annual mobile phone bill

You could be one of the millions of people paying too much for your mobile phone. Here are some top...

Close