In This Article
What is the difference between a repayment mortgage and interest only?
A capital and repayment mortgage means that each month, when you make a mortgage payment, you are paying both the interest on the loan, and reducing the balance owed.
As a result, your mortgage payment is higher than what it would be for an interest only payment.
Most mortgages are on a capital and interest basis, especially when you are a first-time buyer with a low amount of equity.
Although there is a higher monthly cost, the benefit is you are paying off your mortgage each month, and would be mortgage free at the end of the term.
This is not the case with an interest only mortgage.
On an interest only mortgage, you are only paying the interest payment each month, with the balance remaining level throughout the term.
At the end of the agreed term, you would then pay back the balance in full to clear the loan.
For many people, this may mean selling the property if they do not have another method to make the repayment.
Both repayment methods would suit different people, but in general, interest only mortgages are considered high risk due to uncertainty around repayment methods in the future.
You should always take professional advice if you are considering taking a mortgage.
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Can first time buyers get interest only mortgages?
It is possible for first-time buyers to get an interest only mortgages.
However, more often than not, they find themselves outside of the lender’s criteria due to the minimum amount of equity required for an interest only application.
Unless the applicant has a qualifying repayment method (for example, an investment account with funds equating to the full balance of the mortgage), a common repayment method is downsizing by sale of the property in the future.
For this, there must be enough equity in the property to make this repayment method plausible.
For instance, if somebody who owns a house worth £1,000,000 with 5 bedrooms with a mortgage of £500,000 and plans to downsize at the end of the mortgage term to a three-bedroom property, worth £500,000, this may be plausible.
If however, somebody had a property worth £250,000, with a £125000 mortgage on it, and also plans to downsize, this may be less realistic.
This is not to say that some lenders would not accept it, but they would need to get an idea of where you plan to move to, and it would be possible to buy a property there for £125,000.
As most first-time buyers have smaller deposits, for instance, less than 20%, many do not have enough to qualify for an interest only mortgage on their first property.
This is often not a bad thing, as mortgage advisers usually recommend that first time buyers build equity within their property by reducing their mortgage over the years.
To find out what is most suitable for your situation, speak with a mortgage adviser.
What are the disadvantages of interest only mortgages?
The main disadvantage for interest only mortgage is that you are not paying down your mortgage balance over time, with it remaining level.
If your property does not appreciate by the amount that you require in order to move to an acceptable property in the future, this could leave you stuck.
At the end of the mortgage term, your lender will need the mortgage to be repaid which could mean either selling the property or refinancing.
If your equity in the property is low, you may find it difficult to buy another home that meets your needs.
Additionally, if you need to refinance it instead, if the property has not appreciated greatly over time, your loan to value could still be high.
This may mean that you would need a repayment mortgage in order to refinance the loan.
If you are older, the term offered by the lender is usually lower which would result in high monthly payments on a repayment mortgage.
This is why reducing your mortgage from the outset is often recommended when someone is entering onto the property ladder in need of growing equity.
Furthermore, over the duration of a mortgage term, you will pay more to the lender on an interest only basis, than you would on repayment.
This is because you’re paying interest on the full balance of the mortgage throughout the term, and then making a final payment of the original principal.
On a repayment mortgage, the amount of interest you are paying becomes less as the loan reduces.
Is it better to overpay an interest only mortgage or take a repayment mortgage?
An alternative method to taking a capital and repayment mortgage, is to borrow on an interest only basis and make overpayments on the mortgage.
Many mortgage products allow overpayments throughout the term, sometimes capped at a certain amount, for instance, 10% per annum.
It means that each year you can pay off a chunk of your mortgage, in order to reduce it over the term. Some lenders even allow you to set up a standing order, so it is paid each month.
It can be set up so it reduces in the same fashion that a repayment mortgage would.
The benefit is, if cash flow ever became a problem and you needed to cancel the standing order (not the direct debit you are obligated to pay), you could stop making this overpayment and pay just the interest only amount.
This gives you control over your finances in difficult times.
To find out whether you should take a repayment mortgage or interest only with overpayments, speak with a professional mortgage adviser.
Are buy to let mortgages interest only or repayment?
Buy to let mortgages are often arranged on an interest only basis.
This is not the case for all buy to let mortgages, and it is for the landlord to decide what is best for them.
The benefit of interest only borrowing on buy to let mortgages is the additional cash flow that the property will generate.
If the mortgage payment is lower, this will result in more money going into the bank account that could go towards income or property expenses in the future.
Some landlords even save up additional cash flow from their buy to let properties, to go towards another purchase.
The disadvantage, of course, is that the mortgages are not reducing over time.
Some landlords are not concerned about the additional cash flow, and their priority is to reduce the debt over the course of the mortgage.
Some landlords are buying their buy to let properties with retirement in mind.
If they can have the mortgage paid off by the time they retire, this would allow the properties to generate a larger retirement income, as there would be no mortgages to pay. Some individuals still require a mortgage into their retirement.
Again, different methods to different people, so you do your research and get expert advice.
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Are commercial mortgages interest only or repayment?
More often than not, commercial mortgages are on a repayment basis.
Terms are often shorter on a commercial mortgage, for example, 10 to 15 years. This means that after this, you or your company would own the commercial property.
It may however be possible to get a commercial mortgage on an interest only basis, depending on the situation.
If it was to buy property for rental, for instance, or a building with multiple flats, there are lenders that can offer this.
There are usually lenders available to buy different commercial properties on an interest only basis too.
Interest only commercial mortgages may make sense to businesses that are prioritising cash flow.
With a lower monthly mortgage payment, there is more money in the bank accounts to run the business with. However, paying off the mortgage over the term is certainly a major advantage.
You should talk to an experienced commercial mortgage adviser to discuss your individual situation and what terms may be offered on a commercial mortgage.
Conclusion
Whether interest only or repayment mortgage are right for you, this will depend on your own situation and objectives.
Usually, repayment mortgages are recommended so an applicant can build up equity within their property.
This may not be so important if the property is an investment property requiring cash flow, or if you have a large amount of equity in your house already that is sufficient to downsize with.
This is however an important thing to take into account when choosing a mortgage, and professional advice is highly recommended.
You should talk to your mortgage adviser who can understand your situation and point out the full pros and cons of each route.
If you would like I NEED ADVICE to match are you with an experienced, regulated mortgage adviser that can discuss both repayment and interest only mortgages, please complete the contact form.
The information on this page is not tailored to any individual readers and should not be considered financial advice under any circumstances.
If you are seeking advice about a mortgage, you should consult a qualified professional.
