A Complete Guide to Interest-Only Mortgages

Interest-only mortgages are slightly more complex than their capital and repayment counterparts but, for some borrowers, they could fit the bill.

This guide will tell you everything you need to know about these types of mortgages, how they differ from the repayment version, which lenders offer them and where to look if you need help finding the best one for you.

What is an interest-only mortgage?

An interest-only mortgage is a type of home loan where you only pay off the interest each month, rather than a portion of the capital as well – although you may be able to arrange voluntary capital repayments, if you wish.

This means the actual mortgage debt remains untouched and isn’t repaid until the end of the mortgage term, when a pre-agreed repayment vehicle is used to clear the full loan amount.

The main advantage is the monthly repayments are much lower, as you’re not repaying any part of the original amount borrowed, just the interest.

However, this also means you must have an alternative repayment method in place to cover this amount by, if not before, the end of the term.

Are they still available for residential properties?

Yes, they’re still very much available. Although they tend to be the most popular choice for people looking at buy-to-let properties, some lenders are happy to offer them to residential buyers who can evidence a strong enough repayment vehicle.

Interest-only mortgages aren’t for everyone and it’s essential to speak with an experienced broker before deciding which type of home loan is right for you.

Types of repayment vehicle

A repayment vehicle is often referred to as an ‘exit plan’ and, as the name suggests, is your means to repay the full loan amount at the end of the term.

You’ll need this in place before a lender will approve offering your interest-only mortgage.

The repayment vehicle is a separate arrangement to your mortgage but runs alongside.

It can basically be anything you like – as long as your lender accepts its validity – and is often in the form of an investment, such as:

• Endowment policy
• Stocks and Shares ISA
• Share portfolio
• Buy-to-let property portfolio
• Pension fund

Whichever exit strategy you choose, the key aim is that the accumulated returns will leave you with enough to repay your original loan at, or even before, the end of the mortgage term.

There are other potential repayment vehicles for interest-only mortgages too. A popular option is to simply sell the property at the end of the mortgage term, hopefully making a profit on the original amount paid.

Alternatively, you may be planning on remortgaging to a repayment deal in a few years’ time, perhaps only using an interest-only product as a short-term solution to benefit from lower repayments.

The key thing to remember is that there’s no guarantee with any repayment vehicle.

Your investments may not perform well enough to repay the full loan amount or your circumstances could change and mean that remortgaging isn’t an option.

Interest-only vs. repayment mortgages

If interest-only mortgages are exactly as they sound – where only interest is paid each month – so too are repayment mortgages, where your monthly payments include a portion of the loan as well as interest, so the full amount is guaranteed to be repaid by the mortgage end date.

The biggest difference, at least for borrowers’ finances, is in terms of the monthly payments, which will be far higher for a repayment mortgage as you’re chipping away at the capital as well.

Let’s say you’ve got a mortgage of £200,000 with an interest rate of 2% and a term of 25 years. In the interest-only arrangement, your monthly repayments would be just £333 (at an interest rate of 2% your annual interest would be £4,000, equating to £333 per month). In the repayment scenario, you’d be paying £848 per month.

Try our calculator below to get an idea of how your repayments could differ on a repayment mortgage versus an interest-only deal.

Though the lower repayments of an interest-only mortgage may initially seem appealing, the clear downside is that you’re not actually paying off any of the loan, and there’s no guarantee that you’ll be able to clear it at the end of the term.

Other key differences would be:

• As the value of an interest-only loan is never reducing, you may actually end up paying more interest over the term of the mortgage.
• With a repayment mortgage, as the capital reduces your level of equity increases, potentially giving you access to lower rates throughout the term of the loan
• The more defined repayment structure makes capital and repayment mortgages seem much less risky and, generally, more appealing to the wider market

Can you switch to a repayment mortgage at a later date?

Yes. If you’re approaching the end of your interest-only mortgage term and find you’re unable to repay the loan, you may be able to remortgage to a repayment arrangement, though this will depend on several factors including your age and credit profile.

Of course, you may simply want to switch to a repayment mortgage by choice, perhaps because your circumstances have changed and you’ve got additional income to cover higher monthly repayments. Either way, make sure to speak to a mortgage broker who can take you through your options.

Can you get a part repayment/part interest mortgage?

Yes, it’s possible. Part repayment/part interest mortgage offer an attractive ‘halfway house’ option. In this setup you’ll be repaying the interest and some of the loan amount, but not all of it, and will still have a lump sum at the end of the term that you’ll need to repay.

This means you’ll still need to have a repayment strategy to repay the remaining capital, but you won’t need to find quite as much cash as with a pure interest-only deal.

Monthly repayments can be lower than with a repayment mortgage, too, which could offer the ideal compromise for some borrowers.

Try our calculator below to work out what your repayments could look like if you choose this option.

How to get an interest-only mortgage

Think an interest-only mortgage might be for you?

Here’s some simple steps you can take to make the application process much more straightforward:

1. Get your documents together. Getting your documentation together beforehand can save you a lot of time during the process. In addition to your ID/ proof of address, evidence of earnings etc. – crucially for this kind of mortgage – this includes evidence of how you’ll repay the loan at the end of the term.
   This could be details of an endowment policy, for example, a statement of your investment account or stocks and shares ISA, or a mortgage statement of your buy-to-let property. Whatever you intend to use as your mortgage repayment vehicle, make sure to have the necessary details to hand.
2. Check your credit score. Your credit score is key in any mortgage search.
   A clean credit record is essential if you’re to have access to the best interest-only mortgage rates. Checking your credit score in advance allows you to amend any incorrect or invalid information and avoid any nasty surprises during your application; head to our credit check hub to get started.
3. Speak to a broker. The specialist nature of interest-only deals means speaking to an expert broker can be invaluable.
   They’ll have a thorough understanding of the market and the lenders who operate within it, and will be able to use that knowledge to get you the best terms that suit your circumstances.
   They’ll be able to offer advice and support throughout the process too, and with our broker matching service, you can take the hassle out of finding an expert that can help. If you make an enquiry we can arrange for an advisor we work with to contact you directly.

Eligibility criteria

Because they come with an extra element of risk when compared with standard repayment mortgages, interest-only mortgage criteria tends to be stricter.

How much deposit do you need?

You’ll typically find that deposit requirements will be higher, with most lenders only offering interest-only mortgages at up to 75% loan-to-value (LTV), with some topping out at just 50%.

There are exceptions – some lenders will increase this to 80% or even 85%, but your application will need to be strong in all other areas.

How much income will you need?

Income requirements can often be significantly higher as well – some lenders expect at least one applicant to be earning a minimum of £75,000, or even as much as £100,000.

There are exceptions, but in many cases this puts interest-only residential mortgages out of reach of many borrowers and means they’re often only suitable for higher earners, who may be more able to arrange suitable repayment vehicles as well.

Your repayment vehicle

Your exit strategy will need to be set in stone before your application will be approved, and you’ll normally be contacted throughout the term of the mortgage to make sure that this remains on track.

Not all lenders will accept the sale of the property as a suitable repayment vehicle – if this is your preferred route, make sure to speak to a broker who knows the lenders that you’re best approaching and, crucially, the ones who won’t consider your application.

Which lenders are available?

Though there are several lenders able to offer interest-only mortgages, because of the stricter eligibility requirements, they may not be readily available to all borrowers.

Increasingly, it tends to be specialist lenders who’re more willing to consider applications for this type of home loan.

For example, although NatWest, Barclays, HSBC, Nationwide and Virgin Money all offer interest-only deals, they’re restricted to those earning at least £75,000 (or £100,000 in the case of HSBC), which means it’s often necessary to seek smaller providers.

Many of the best interest-only products are only available via brokers, too, with the specialist and high-risk nature of these mortgages meaning a lot of lenders expect you to seek suitable advice before committing to this kind of agreement.

This is where we can help! With our network of advisors, we’ll be able to point you in the direction of the lenders best placed to accommodate your needs.

How to find the best rates

Many of the best interest-only mortgage rates are only available via brokers, who will also be able to advise you on the term that would be right for you.

For example, 2 year fixed rates may be readily available, but will they be better than a 5 year fixed, or perhaps a variable rate deal?

Other borrowers may want the security of a 10 year fixed rate, but will it be the most cost-effective over the long term?

The only way to know for sure is to speak to an advisor who will be able to scour their network and negotiate on your behalf, finding the mortgage rate that’s perfect for your needs.

What types of interest-only mortgages are available?

What happens if you can’t pay off your interest-only mortgage?

There may be occasions where you’re approaching the end of the mortgage term and find you don’t have the means to repay the loan.

Perhaps your investments haven’t performed as well as you’d hoped, or the housing market has fallen and selling the property won’t repay the loan.

In any scenario where you’re unable to repay the full amount, you have a few options open to you:

• Sell another property (perhaps a buy-to-let or second home)
• Ask your provider for an extension
• Remortgage, perhaps to a full repayment product
• Use your pension (if applicable)
• Switch to a retirement interest-only deal or opt for equity release (if you meet the age criteria)
• Downsize to a smaller property

There may be other solutions available as well depending on your circumstances, but with any option the key is to speak to your provider as soon as you know you may be facing difficulties, even if you’re years away from your mortgage end date.

That way you can put a plan in motion ahead of time, and hopefully won’t be facing the more extreme steps of repossession or loss of additional assets, which can be a possibility if all other routes fail. If you think this could be on the cards, make sure to seek suitable advice.

Speak to a broker who specialises in interest-only mortgages

Finding the right broker can sometimes be just as challenging as finding the ideal mortgage, but at Online Money Advisor we make it very simple.

By letting us know your requirements we’ll scour our broker network to put you in touch with an expert interest-only mortgage specialist that can manage your application from start to finish, leaving you with the deal that’s right for you. Call 0808 189 0463 to get started or make an enquiry.