When you take out an interest-only mortgage, the monthly payments are around half of what they’d be for a repayment mortgage. Sounds tempting, right?
But before you take the plunge, it's important to know that at the end of an interest-only mortgage term, you'll still owe exactly the same amount as what you very first borrowed.
Whereas at the end of a repayment mortgage term, your home is all yours and the debt is paid off.
That said, there are times when an interest-only mortgage might suit your needs.
Let’s take a look at the pros and cons of both types of mortgages.
What are the differences between interest-only and repayment mortgages?
With an interest-only mortgage, you only pay interest on the amount you owe each month. You don’t pay off any of the lump sum that you first borrowed.
With a repayment mortgage, you pay both the interest on the loan and a portion of the lump sum borrowed. So that at the end of the term, the mortgage is paid off completely.
Are interest-only mortgages cheaper than repayment mortgages?
Yes. The big advantage of an interest-only deal is that the monthly payments are much cheaper than with a repayment one.
The monthly payments on a £200,000 interest-only mortgage over 25 years at a rate of 4.5% would be £749.
While the monthly payments on a £200,000 repayment mortgage over 25 years at the same rate would be £1,111.
Work out how much you'll pay each month on a repayment mortgage with our mortgage calculator.
Just enter a few details - like the property price, deposit amount and interest rate - and you'll see what your monthly payments would be.
What are the disadvantages of an interest-only mortgage?
Interest-only mortgages are more expensive over the long-term as you pay a lot of interest.
With a repayment mortgage, you’d pay a total of £133,370 in interest on a £200,000 mortgage at 4.5% over 25 years.
With an interest-only mortgage, you’d pay £224,808 in interest, and you’d still owe £200,000 at the end of the 25 year term.
Do you ever pay off an interest-only mortgage?
You don’t pay off the mortgage on a monthly basis with an interest-only mortgage.
Instead you’ll need to pay a lump sum at the end of the term to pay it off.
How do I pay off my interest-only mortgage?
There are no hard and fast rules for how to pay off an interest-only mortgage.
You can set aside money each month into a savings account to cover the final repayment. You could also use a lump sum pension payment.
In the past, it was popular for people to invest the money they would have used for repayments into shares. But that's now considered to be a high-risk strategy.
You could switch to a repayment mortgage down the line if you’re expecting your salary to increase.
Or, in the most extreme case, you could sell your home to repay the money. But this too is a risky strategy, as if house prices fall, you could end up owing more than your property is worth.
You’re also unlikely to want to sell your home.
Is it hard to get an interest-only mortgage?
In theory, it’s harder to get an interest-only mortgage than a repayment one.
Not all lenders offer them and those that do tend to ask for a large deposit.
If you don’t have a realistic way to eventually clear the debt, you’re likely to be refused an interest-only loan.
Is it better to take an interest-only mortgage or a standard repayment mortgage?
Generally, for most homeowners, a repayment mortgage is the better option. You’ll pay less interest over time and your home is yours as the end of the deal.
However, if you’re an investor who wants to sell their property further down the line, an interest-only mortgage might be right for you.
With reduced mortgage payments, more of your monthly rental income can go directly to you, rather than to your lender.
Equally, if you’re a homeowner who’s suffered a temporary loss in income, switching to an interest-only mortgage might be useful as a short-term measure to reduce your monthly outgoings.
How long can you pay an interest-only mortgage for?
Interest-only mortgages generally have the same terms as repayment mortgages. The standard term is 25-years.
But unlike with a repayment mortgage, increasing the term won’t lead to lower monthly repayments.
What happens if I overpay on an interest-only mortgage?
You can make overpayments on an interest-only mortgage. But it will only reduce your future interest payments.
Overpaying won’t reduce the overall amount you owe.