What Is An Interest Only Mortgage?

When financing a home, the wide range of mortgage options available can be overwhelming, as they all offer different requirements and criteria.

Among these options, one term that often surfaces is "what is an interest-only mortgage."

While it may seem straightforward, the concept behind an interest-only mortgage can be complex when paired against the standard repayment mortgage.

In today's housing market, where financial flexibility and alternative repayment structures are increasingly sought after, interest-only mortgages have gained popularity among homeowners, landlords and investments alike.

They are designed to provide short-term financial relief or accommodate specific financial strategies; these mortgages offer distinct advantages and considerations that borrowers should be well-versed in.

One issue many homeowners have is what happens when they need to pay off the loan at the end of the term and move house.

In this article, we will cover the basics of mortgages, what types of mortgages are available and if interest-only mortgages are suitable for you.

What Is A Mortgage?

On a fundamental level, a mortgage is a loan which helps you buy a house.

When you enter into a mortgage, you are entering into an agreement with a building society or mortgage lender that if you cannot make the mortgage repayments, they can take back ownership of the property.

At the start of the mortgage process, you will need to put down a percentage of the cost of the property value as a deposit, and then the rest of the money is provided by the lender in the form of a mortgage.

Can You Get A Mortgage On Any House?

Different mortgage providers have other lending criteria, meaning different lenders specialise in different properties. This being said, you should always do your due diligence to see if a property is unmortgageable.

Can You Have More Than One Mortgage?

Legally, you can have as many mortgages as you want. However, as mortgages present some of the most significant investments and loans a person may take in their lifetime, taking out multiple mortgages may be a severe financial risk.

The only issue is that you may need help finding a mortgage lender that will provide multiple mortgages as this is deemed high risk. You must show you can make the mortgage payments and have severe financial stability.

Can You Sell A House With A Mortgage?

You can sell your property with a mortgage if you pay off the loan before attempting to purchase another property.

What Is The Difference Between Interest-Only and Repayment Mortgages?

There are two categories of mortgages; interest-only and repayment mortgages.

Understanding the difference between these two types of mortgages is crucial for homeowners to make an informed decision that aligns with their financial goals and circumstances.

Repayment mortgages allow you to pay off the mortgage interest and some of the capital each month, so the mortgage will be cleared at the end of the term.

Over time, as you make the mortgage payments, the outstanding loan balance gradually decreases until it is fully repaid by the end of the mortgage term.

Whereas interest-only mortgages allow you only to pay off the interest on the amount you borrow, and then at the end of the loan, you pay back the initial borrowed amount.

During the interest-only mortgage term, your monthly payments cover only the interest accrued on the loan without reducing the mortgage balance.

As a result, the monthly payments for an interest-only mortgage tend to be lower than a repayment mortgage.

How Do You Choose The Right Category Of Mortgages?

Interest-only mortgages offer lower monthly payments during the interest-only term compared to repayment mortgages, and this can provide short-term affordability and allow borrowers to manage their cash flow more efficiently, especially in the early years of homeownership.

Some borrowers choose interest-only mortgages as part of a strategic investment plan; for example, some landlords will use interest-only financing to minimise their monthly expenses, enhance cash flow and allocate funds for acquiring additional properties.

Interest-only mortgages also allow borrowers anticipating a significant increase in their income to opt for an interest-only mortgage initially and swap to a repayment plan later.

Whereas one of the primary advantages of a repayment mortgage is that it allows borrowers to build equity in their property over time steadily.

With each monthly payment, a portion goes towards reducing the capital balance, increasing their ownership take, and lowering outstanding debt.

Where interest-only mortgages offer short-term stability, repayment mortgages provide long-term stability and are suitable for individuals who want to become mortgage-free and free up future cash flow for other investments.

What Is The Difference Between Interest-Only and Repayment Mortgages?

There are two categories of mortgages; interest-only and repayment mortgages.

Understanding the difference between these two types of mortgages is crucial for homeowners to make an informed decision that aligns with their financial goals and circumstances.

Repayment mortgages allow you to pay off the mortgage interest and some of the capital each month, so the mortgage will be cleared at the end of the term.

Over time, as you make the mortgage payments, the outstanding loan balance gradually decreases until it is fully repaid by the end of the mortgage term.

Whereas interest-only mortgages allow you only to pay off the interest on the amount you borrow, and then at the end of the loan, you pay back the initial borrowed amount.

During the interest-only mortgage term, your monthly payments cover only the interest accrued on the loan without reducing the mortgage balance.

As a result, the monthly payments for an interest-only mortgage tend to be lower than a repayment mortgage.

How Do You Choose The Right Category Of Mortgages?

Interest-only mortgages offer lower monthly payments during the interest-only term compared to repayment mortgages, and this can provide short-term affordability and allow borrowers to manage their cash flow more efficiently, especially in the early years of homeownership.

Some borrowers choose interest-only mortgages as part of a strategic investment plan; for example, some landlords will use interest-only financing to minimise their monthly expenses, enhance cash flow and allocate funds for acquiring additional properties.

Interest-only mortgages also allow borrowers anticipating a significant increase in their income to opt for an interest-only mortgage initially and swap to a repayment plan later.

Whereas one of the primary advantages of a repayment mortgage is that it allows borrowers to build equity in their property over time steadily.

With each monthly payment, a portion goes towards reducing the capital balance, increasing their ownership take, and lowering outstanding debt.

Where interest-only mortgages offer short-term stability, repayment mortgages provide long-term stability and are suitable for individuals who want to become mortgage-free and free up future cash flow for other investments.

The Different Types Of Mortgages

There are plenty of different types and variations of mortgages, and it can be hard to compare the benefits and disadvantages of each.

We recommend that you speak to a mortgage advisor or broker who will be able to guide you through the different options better and tailor them to your financial situation.

Here is a quick breakdown of the different types of mortgages:

What Is A Fixed Rate Mortgage?

A fixed-rate mortgage is a mortgage where the interest rate stays the same for the duration of your agreement. The interest on your mortgage will not change over the lifetime of your loan.

Usually, fixed-rate mortgages will last between 2 and 5 years, with 2-year fixed mortgages offering a lower interest rate, but the 5-year fixed mortgage offering more long-term financial stability.

If your fixed-rate mortgage ends before you sign a new agreement, you'll be moved onto a standard variable-rate mortgage (SVR).

What Is A Standard Variable Rate Mortgage?

A Standard Variable-Rate Mortgage (SVR) is a variable-rate mortgage that will be charged once your initial deal period on a tracker or fixed mortgage rate ends.

Your SVR mortgage payments will increase and decrease each month based on the wider interest rate.

You should only stay on an SVR mortgage if you have a realistic repayment plan to pay off your mortgage early.

What Is A Tracker Mortgage?

A Tracker Mortgage is a variable mortgage that tracks the base rate set by the Bank of England.

A downside to tracker mortgages is that as they are vulnerable to the base rate, they may exceed the current fixed rates.

What Is An Offset Mortgage?

An offset mortgage is linked to your savings account, in which the sum of your account is used to offset the interest you are charged on your repayments each month.

Offset mortgages can be a great way to make your mortgage repayments cheaper, but you won't benefit from earning interest on your savings account.

What Is A Joint Mortgage?

Joint mortgages allow two or more people to purchase a home together, allowing you to combine your money for the mortgage deposit.

All parties within the joint mortgage are responsible for the mortgage repayments. Mortgage lenders prefer married couples or in a civil partnership to enter into joint mortgages.

What Is A Discount Mortgage?

A Discount Mortgage is a discounted variable rate as it has an interest rate set at a predetermined amount below the mortgage lender's standard variable rate, which increases and decreases as the SVR moves.

What Is An Interest Only Mortgage?

Interest-only mortgages are on an interest-only basis, allowing you only to pay the interest on what you borrowed each month instead of back the payment. Only when the interest-only mortgage ends do you pay back the payment.

Interest-only mortgages are for people who can save enough for eventual mortgage repayment at the end of the mortgage. They will need many funds available, which could apply to someone who has an inheritance property or can afford to remortgage.

How Do Interest-Only Mortgages Work?

During the interest-only mortgage, you only pay the interest monthly during the term, which might be as short as a few years or as long as 20 years. Once the mortgage term ends, you must repay the lender the initial borrowed amount.

You must prove to your mortgage lender that you can and means to pay off the total amount, known as a repayment vehicle, at the end of the term. This may take the form of an investment or ISA.

How Do You Calculate Interest Only Mortgage Payments?

The monthly payment on an interest-only mortgage is quite simple, just the interest on the total sum.

For example, if you borrow £250,000 on a 3% mortgage, your annual interest will be £7,500 - so your monthly payment will be divided by 12, or £625.

Over 20 years, you will pay £150,000 in monthly payments, but you will also have to repay the mortgage of £250,000, which means in total, you'll repay £400,000.

What Are The Benefits Of Interest Only Mortgages?

Interest Only Mortgages offer a wealth of benefits, but most will differ depending on the preferences of the person who has taken the loan.

The monthly payments are far lower than with a repayment mortgage, as you only pay the mortgage loan's interest.

If your investments work well, you can pay the mortgage back quicker than with a repayment mortgage and without having to sell or remortgage.

What Are The Disadvantages Of Interest Only Mortgages?

Interest Only Mortgages also have disadvantages, like the pressure of knowing you must repay a large amount of money at the end of your mortgage term.

You will usually pay more interest overall than with a repayment mortgage because the amount you pay interest on doesn't decrease during the term.

You will only pay off the interest each month and still owe the total amount at the end of the term.

You will have to look after your repayment vehicle and your mortgage, and if your repayment vehicle relies on an investment, pension fund or inheritance, it may not make enough to pay off the mortgage.

Is An Interest-Only Mortgage Right For You?

Deciding whether an interest-only mortgage is right for you, will require careful consideration of your financial situation, goals and risk tolerance.

While an interest only mortgage offers certain benefits, it's important to weigh them against potential risks like short term affordability, future income perspectives, and also long term financial suitability.

Interest-only mortgages can be a precarious and expensive investment for most homeowners, but they may allow some people to generate a profit as their repayment plan will enable them to make more than they pay off.

Most landlords prefer interest-only mortgages as they keep their overheads low. The mortgage can eventually be repaid by selling the property, so provided they can afford the initial deposit, interest only is often their best bet.

But, as interest-only mortgages aren’t a one shoe fits all mortgage, It's vital that you consult with mortgage professionals who will provide you with personalised advice based on your own circumstances.

They can access your eligibility, help you compare mortgage options, and guide you towards a decision that aligns with your best interests.

Ultimately, choosing an interest only mortgage should be a well-informed decision that supports your long-term financial objectives and matches your comfort level with associated risks.

How Do You Pay Off An Interest Only Mortgage Early?

Several ways to repay your interest-only mortgage include remortgaging, using savings or investments and selling the property.

Remortgaging

One way to repay an interest-only mortgage is to take out another mortgage, which could be a repayment or interest-only mortgage.

But, you will need to ensure that you meet the mortgage lender's criteria, and you will be older by the time you remortgage, and your circumstances will have changed.

Remortgaging can be advantageous if you want to stay in the property while paying off the original mortgage. This could be done by switching from an interest-only mortgage to a fixed-rate mortgage.

Savings Or Investments

Another way of repaying your interest-only mortgage is to pay it off with any other accumulated money from savings or investments.

Selling The Property

You can also sell your property to pay off your interest-only mortgage, as long as the amount you sell the property covers the entire loan amount. Otherwise, you will have to cover the shortfall if you sell your property and run into negative equity.

One of the easiest ways to sell your home is through us!

We are a cash buyer and can buy your property in as little as seven days, meaning we can take your property off your hands as soon as you hit the end of the mortgage term — as long as you won't enter negative equity.

Here at The Property Buying Company, we can buy any house in any location. We will even cover all the fees typically associated with selling your home, including your legal costs.

As a genuine cash buyer, we have the cash funds readily available to buy your property in three months or seven days; we will tailor the house-selling process to your goals.

We are proud members of the National Association of Property Buyers and The Property Ombudsman and have been rated excellent on Trustpilot by hundreds of homeowners.

Ready to get started?