Interest only mortgage guide
In this guide you can learn about interest-only mortgages, how they work and who they are suitable for.
Applying for a mortgage involves lots of small but important decisions and one of those is the repayment method. Most borrowers choose to set their loans up on a full repayment basis.
But for some, the interest only alternative can be the best option. Our guide walks you through the differences between these two methods and explains how you can qualify for interest-only.
If you’re considering taking out an interest only mortgage, there’s a lot to think about. Not only do you need to understand how interest only mortgages work and the potential risks associated with them, but you also have to decide whether this type of loan is right for your individual needs.
Our interest only mortgage guide provides all the information you need to make an informed decision when it comes to choosing the best loan for your circumstances.
From outlining the advantages and disadvantages of using interest only mortgages, to helping you find the most competitive deals on the market – read on for everything you need to know about interest only mortgages.
Table of Contents
- What is an interest only mortgage?
- Are interest-only mortgages still available?
- How do you repay the mortgage?
- Eligibility criteria
- Calculating the monthly payments
- Advantages
- Disadvantages
- Interest only vs repayment
- Part and Part explained
- Who are interest-only mortgages suitable for?
- Where can you get them from?
- What happens when the mortgage ends?
- How a broker can help
What is an interest only mortgage?
When you apply for a mortgage you have to select a method of repayment.
There are two main choices:
- Repayment (capital & interest)
- Interest only
With an interest only mortgage your monthly payments to the lender are only made up from the interest you have been charged. This stops the mortgage balance from increasing but also means that, as no money is going towards the debt repayment, the balance never decreases.
They are popular with property investors and landlords but the majority of people will have a standard repayment mortgage for their home.
How do they work?
So each month the lender will only be expecting payments for the interest charged on the mortgage debt. These payments will be quite a bit smaller than the cost of a repayment loan.
There’s no requirement for any capital repayments at all.
As each year passes the mortgage balance remains the same.
At the end of the term the lender will be expecting you to make a full repayment of the whole debt, all in one go.
Are interest-only mortgages still available?
Yes they are still available.
Since the financial crisis of 2008 and subsequent changes to mortgage affordability, lenders have not been as keen to offer interest only mortgages, particularly for residential mortgages.
It’s still quite straightforward to obtain a buy to let or holiday let mortgage but the maximum LTV for these tends to be 75% anyway.
When applying for a residential mortgage (for your own home) you will need a minimum of a 25% deposit and the lender needs to be happy about how you intend to pay them back.
How do you repay the mortgage?
How you will repay the loan is arguably the most important aspect, and something that all lenders will be very interested to understand.
The details of the ‘how’ are less important for investment property mortgages, which are unregulated anyway. But where the mortgage is linked to your main residence the ‘how’ needs to be approved by the lender.
There’s no single option for how this can happen, each borrower will have their own take on the best way and some of the ideas below can be combined.
Some of the strategies are:
Downsizing
Sell your property, repay the mortgage and use some or all of the remaining money to buy a cheaper property.
Investments
This is a popular choice and could include: savings, investments, stocks and shares, ISAs, endowments etc. Could also be used to repay ad hoc as plans mature.
Sale of second property
If you own other properties then these could be sold and the proceeds used to pay off the mortgage.
Ad hoc payments
Perhaps you have a job where bonuses are paid every year or so. These can be used as one off repayments during the mortgage term, reducing the balance and the interest charges.
Pension lump sum
Most pension schemes will allow a tax free lump sum to be taken out, which can be used to repay the mortgage.
Switching repayment method
You don’t have to stick with the same repayment method for the whole mortgage term. One option could be to switch over to a repayment mortgage after the first 5 years.
Equity release
Technically this is not repaying the debt, more refinancing it. Nevertheless, using an equity release plan is a solid strategy but the viability will depend on your age and potential loan to value.
Keeping it on track
It’s a good idea to regularly check whatever plan you have, to make sure that it’s still on track.
Things can change over such a large timeframe and so tweaks maybe needed to bring it back on course.
While the lender might enquire about this from time to time, it is your responsibility to come up with the money!
Eligibility criteria
The basic eligibility criteria will be the same as for other loans:
- UK resident over 18
- Provable income
- Good credit history
- Property in good condition
Regardless of the mortgage type, lenders will be cautious about lending on a property of non-standard construction. So a timber framed property, listed building or Precast Reinforced Concrete (PRC) property will all need a specialist lender.
A guide to the different types of houses in the UK
Your plan to repay the mortgage will be top of the lender’s list of requirements. If this is not acceptable to them then the loan application will be declined.
How much can you borrow?
The exact amount you can borrow will always depend on the lender and what you can prove as your annual income. But as a guide, a single applicant should be able to borrow 4.5 to 5 times their annual gross income. (Certain qualified professionals can borrow more)
For example: £50,000pa multiplied by 4.5 = £225,000
Your income needs to meet the lenders minimum for an interest only mortgage, and this can be higher than a normal capital and interest arrangement. You also need to be able to demonstrate that the monthly payments are affordable. If you are a high earner or have a decent amount of savings, you stand a better chance of being accepted for an interest-only mortgage.
How much can I borrow calculator?
LOAN TO VALUE
The loan to value (LTV) is a percentage figure that represents what proportion the mortgage is when compared to the value of your home.
For example: The loan to value for a £150,000 mortgage on a £250,000 house would be 60%. If you were buying this property you would need a deposit of £100,000 (40%).
Lenders prefer a lower LTV for interest only mortgages, so budget for a minimum of 25% deposit.
INVESTMENT PROPERTY MORTGAGES
The rules are slightly different for buy to let and holiday let mortgages.
First, the borrowing is largely based on the gross rental income. Second, lenders will be happier with an interest only mortgage and 75% LTV is routinely available.
Calculating the monthly payments
It’s quite simple to work out the monthly payment for an interest only mortgage, as we only need to consider the interest charged.
For example: If you borrow £250,000 with a 4% interest rate, the annual interest charged would be £10,000. £250,000 times 4% = £10,000.
Divide the £10,000 by 12 (months) to get the monthly payment of £833.
While this may sound great, let’s not forget that none of the £833pm goes towards repaying the £250,000.
Compared to repayment
It’s not really possible to work out the monthly cost of a repayment mortgage yourself. You need a mortgage calculator to do this accurately.
But let’s now compare the interest only figures shown above to the equivalent repayment mortgage over 25 years.
How much will your new mortgage cost each month?
Learn more about the monthly cost of different mortgages, including repayment and interest only. See what happens when you change the term or when the interest rate changes.
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Advantages
The overwhelming advantage is that they are so much cheaper than the equivalent repayment mortgage.
For example: A £400,000 loan at 4% interest would cost £1333pm as interest only and £2111pm as repayment.
That’s a difference of £778, each and every month.
As there’s no fixed repayment plan, you can chip away at the debt whenever you have spare capital, or make regular overpayments that you can control.
If you know that you’ll come into enough money to repay the mortgage in full, a repayment mortgage may not be the best choice. An interest-only mortgage allows you to buy the property now, rather than wait for the lump sum to arrive.
Disadvantages
There are two main disadvantages:
- The mortgage is not being repaid: Borrowers need to be very aware of their situation so that sufficient time is made available to repay the mortgage.
- You will pay more interest over the course of the mortgage than you would do with a capital and interest option. So it is the more expensive option.
There is the risk that whatever plan you had in place to repay the mortgage falls short and does not cover all of the debt.
This happened to many thousands of borrowers who relied on an endowment savings plan to pay off their mortgage.
Interest only vs repayment
The repayment, or capital and interest, method is very much the norm at the moment. It provides a managed and risk free way of repaying a very large debt that is attached to your home.
But back in the 1990’s interest-only was extremely popular and lenders would happily oblige, without asking too many questions.
Prior to this time, it was again the repayment mortgage that was virtually the only way to take out a mortgage. I mean why would anyone want to borrow hundreds of thousands of pounds without a structured way of paying it back!
There’s a place for both options, neither is better or worse than the other. It all comes down to the needs of the borrower and how capable they are likely to be with their finances. But most brokers would agree that the majority of homeowners should hold their main residential mortgage as a repayment loan, each year reducing the debt and increasing the equity.
Part and Part explained
There is actually one more way for a mortgage to be setup. The third, and little known method, is the ‘part and part mortgage’.
The vast majority of mortgages are repayment with some set up as interest-only. But there is a third method called a “part-and-part” mortgage. This is not widely promoted but most lenders should support it, ask your mortgage broker for their guidance.
Part and part mortgages are a hybrid of repayment mortgages and interest only mortgages. You will be splitting the repayment of your debt between repayment (capital & interest) and interest only.
With the repayment portion the debt will gradually reduce as normal but the interest only part stays the same. When the mortgage ends, there will still be a debt to pay off.
CONTACT A MORTGAGE BROKER
If you are ready to take the next step then we can put you in touch with a fully qualified independent mortgage broker.
Who are interest-only mortgages suitable for?
These types of loan certainly aren’t suitable for everyone, but they do have a place and are a useful option for many borrowers.
The main benefit is that the monthly payments are as low as possible, because none of the money is required to pay back the mortgage. So anyone who is in a tricky spot financially, would benefit from this, as it drastically improves the affordability.
As with many things in life, the bigger problem lies a long way away, and it’s important to always acknowledge that this debt has to be repaid somehow, and not to ignore it.
Someone who has recently been divorced or separated may find an interest only mortgage useful, just because it provides some financial breathing space, while they adjust to a new life.
Borrowers who qualify as a professional because of their occupation will often be able to choose interest only.
Property investors tend to like them as it improves the monthly cashflow. Bridging loans are always interest only, as the terms are so short, and they always have to be repaid in full. There’s no point making 6 or 12 repayments before the loan finishes, it just wouldn’t make that much difference.
Sophisticated or high net worth borrowers tend to prefer paying just the interest so their capital can be employed elsewhere.
Where can you get them from?
All lenders will offer an interest-only repayment method, and it is certainly possible to apply for these mortgages directly.
Where the loan is for your own home (residential), the criteria will be much tougher and some lenders may choose not to offer them at all at certain LTV.
To find the lenders that do offer them, including those that have the best rates, you need to work with a whole of market mortgage broker. Not only will they have access to all of the lenders, brokers also get allocated ‘broker only’ deals, at preferential rates not available to the public.
Let Respect Mortgages introduce you to an award winning independent mortgage broker for a free, no obligation chat.
What happens when the mortgage ends?
Unless you have been making over-payments, or adhoc repayments, when your mortgage ends you will owe the same amount as when you started.
Quite simply the lender will be expecting you to pay off the whole debt in one go, as per the mortgage agreement.
This means that you need a solid plan of action for how this is to be achieved.
How a broker can help
If you are considering an interest-only mortgage there will be a few key aspects that need to be addressed.
WHY INTEREST ONLY?
First assess why this type of loan is preferred. Is it because of the flexibility, the lower repayments or something else.
ELIGIBILITY
Are you eligible for this type of mortgage based on your financial circumstances and loan to value percentage.
GETTING THE BEST DEAL
How will you know if the mortgage deal you have found is the best? Perhaps there are alternatives that are cheaper or have other features that would benefit you.
A broker can help you by
Talking through what you need from a mortgage and then finding the best solution
Confirming which lenders are suitable for you
Searching through thousands of deals to find the best for you
Giving qualified advice on the best way to setup your mortgage
Frequently Asked Questions
Paying just the interest on a mortgage doesn’t sound like the most sensible thing to do. But in some situations it can make perfect sense and makes the monthly cost of having a mortgage that bit cheaper.
Yes. The type of mortgage you have will not prevent you from selling your house. However, it’s important to remember that the mortgage balance will not have changed since you first took it out. Like all mortgages, the lender will need the full balance settled by your solicitor on the day of completion.
Most lenders will allow you to alter the mortgage repayment method. If this is going to be for just 12 months then this should be OK but you will need to advise them of the reason.
Interest only mortgages are slowly becoming less popular and harder to find. There are lenders that are happy with a 25% deposit and there are others that need a 50% deposit. Ask your broker to see who offers the best rates.
Yes, the type of mortgage you have should not make any difference. But the process of obtaining an equity release mortgage, or lifetime mortgage, means that the current mortgage needs to be repaid in full.
Yes, and most lenders will be pleased that you want to do this. However, before approving your request they will need to check you can afford the new repayments, which will be more expensive. We have a longer article about this question here.
Read more: What are the different mortgage repayment methods?
You can potentially extend the term of any kind of mortgage. You will need to explain the reason to your mortgage provider and any new term needs to meet their age criteria and affordability. Should this take you over age 65 then the lender will want to see your pension information as the mortgage takes you into retirement.
According to UK Finance there were 702,000 pure interest only mortgages outstanding at the end of 2022. They now represent only 9% of all regulated mortgages.
Yes, most lenders can accommodate this. This type of arrangement is called a part and part mortgage. Part of the mortgage debt is set up on a repayment basis, and the other part will be interest only. This article explains how they work.
Luckily yes, as they are the most popular option for landlords.
