How Interest-Only Mortgages Compare to Capital Repayment Mortgages

If you’re thinking of buying a property and, like many, aren’t in a place to pay the full whack up front, you’ll need a mortgage.

That’s an amount you borrow from a lender and pay back over time with interest.

You then have two choices on how to repay that money: interest-only versus capital repayment.

By reading this guide, you’ll learn how these two mortgage types compare to one another, what their pros and cons are, and gain a better understanding of which one is right for you.

What’s the difference between an interest only and a capital repayment mortgage?

With an interest-only mortgage, you’re only obliged to pay off the interest each month and capital repayments are optional.

The mortgage debt itself isn’t due until the end of the term and is settled through a repayment vehicle, which the lender will want to see evidenced in advance.

This is a stark contrast to a capital repayment mortgage, which involves making interest and capital repayments each month and paying the debt off across the mortgage term, which is typically 25 years, but can be longer or shorter.

The table below offers a quick summary of the key differences between interest-only and capital repayment mortgages…

For example purposes, if you take out a mortgage of £200,000 over 25 years and opt to pay interest-only at a rate of 3%, you’d only be paying £500 a month.

If you add in the capital, that would rise to £948. At the end of the 25 years with interest only, you’d have to pay the £200,000 lump sum but with a capital repayment mortgage it would already be paid off.

Try our calculator below to see how your mortgage repayments will differ depending on which type of agreement you choose.

Very few lenders offer interest-only mortgages. If they do, they tend to want a larger deposit and evidence of the repayment vehicle before they’ll consider mortgage approval.

Repayment vehicles

What each lender accepts as a repayment vehicle is at their discretion, but an experienced broker will know which lenders accept what.

A few valid options for you to consider include:

1. Your property. The money from a future sale can be used to pay off the capital.
2. A lump sum from a pension plan. You’re able to take out up to 25% of your pension tax free when you retire – this could be arranged to coincide with the end of your mortgage term.
3. Investment portfolio. This can include ISAs, Unit Trusts, Open Ended Investment Companies (OEICs), stocks and shares and/or investment bonds.
4. Family inheritance or trust fund.

The brokers we work with can offer further guidance on which repayment methods to pursue and how to do so.

Pros and cons

Still swaying on where you might land in terms of repayment? There’s no right or wrong option.

While capital repayment is the most popular method, interest-only has its advantages too, especially if you’re considering downsizing or buying-to-let.

Interest-only

The advantages of interest only are as follows…

• Lower monthly repayments. Leaving the capital by the wayside means it’s just the interest you’re paying.
• Optional capital payments can be made: If you want to chip away at your mortgage debt during the term, many interest-only mortgage lenders allow this.
• Good option for retirees and buy-to-letters. If you plan to downsize when you retire, the equity from your existing property can be used to pay off an interest-only loan. And it’s assumed if you’re buying a property to rent it out that eventually it’ll be sold following market growth.

Possible drawbacks to consider include…

• Repayment vehicles can be uncertain: If you’re planning to settle the mortgage debt with an investment, for example, there’s no guarantee it will generate the amount you need. Selling the property might even leave you with a shortfall if its value has dropped.
• Bigger deposit needed. It’s common for lenders to look for upwards of 25% of the total mortgage for the deposit in an interest-only situation.

Capital repayment

The advantages include…

• Less risk. This type of mortgage doesn’t leave you holding out hope for a cash influx further down the line.
• Lower deposit required. A typical deposit sits upwards of 10% to 15% of the mortgage.

Potential disadvantages…

• Higher monthly repayments. Paying both interest and capital means the amount coming out of your account each month will be higher than the interest-only option.

How a broker can help you choose the right mortgage type

Brokers are able to talk you through each option in more detail, familiar with lenders and their requirements, experienced in both types of repayment model, the mortgage brokers we work with are a one-stop shop when it comes to the mortgage process.

They…

1. Understand the intricacies of both interest-only and capital repayment;
2. Have existing relationships and knowledge of lenders offering these two options;
3. Can offer tailored advice to your specific circumstances.

If you already know which way you’d like to go, they can also get the ball rolling in terms of your mortgage application and make sure you get the best deal.

Interest rates for interest-only and capital repayment

The table below provides an illustration of the best interest rates currently available (May 2023) for both interest-only and capital repayment mortgages:

Please note that the above rates were accurate at the time of writing (May 2023), but are always subject to change. Speaking to a mortgage broker is the best way to find the most up-to-date deals.

Can you switch from one to the other?

Yes. Whatever decision you make doesn’t mean you’re bound to it forever.

If your situation changes, you can switch from one type to the other – with your lender’s approval – be it permanently or temporarily.

Just check you’re not in the Early Repayment Charge period on your existing mortgage. If you are, there might be a fee to pay.

Repayment to interest-only

The first thing to ask yourself is if you’re eligible.

Do you have a repayment vehicle in place for the end of term payment?

If you do, then it’s best to connect with a broker specializing in changing mortgages.

They’ll work with you to consider your credit history, income, and the amount of equity in your property – all things a lender will be looking at during the application for a switch.

Interest-only to repayment

First, consider if there are any steps you could take beforehand.

Would making additional payments towards your repayment vehicle or a few mortgage overpayments be alternative solutions?

If not, and a switch is the right step for you, then take a look at your finances to make sure you’ll be able to afford the repayments, which are likely to be higher in a repayment mortgage.

You can then choose to:

1. Stay with the same lender, same agreement and interest rate just switch to a repayment mortgage
2. Get an entirely new repayment mortgage with the same lender
3. Remortgage and try to find a better deal with a new lender
4. Take a hybrid approach via a part-and-part mortgage (see below)

Part-and-part mortgages

A combination of both repayment and interest-only models, this type of mortgage allows you to pay off some of the mortgage but also means there’ll be an amount, the interest, left to pay at the end of the term.

It’s a way of ensuring there’s less to pay at the end than there would be with an interest-only model but also means your monthly repayments don’t have to be as high as they would be with repayment.

It allows for more flexibility and the tailoring to amounts that suit you.

But, just like with interest-only, a lender will need to see you have a way of paying back that lump sum, albeit a smaller one, at the end.

A broker can negotiate this type of mortgage with your existing lender or find you a new one.

Try our calculator below to see what your monthly payments could look like if you choose this type of agreement.

Get matched with the right mortgage broker today

There are lenders who are best placed when it comes to capital repayment, others for interest-only and some with a specialism in part-and-part mortgages.

Working with a broker can save you the hours of sifting through endless websites looking for the right one. After a quick consultation, they’ll know which is right for you.

If mortgage advice and repayment guidance is something you need, a free consultation with one of the brokers we work with can be a big help.

Call 0808 189 0463 or make an enquiry. We’ll then reach out to a broker best suited to your situation and set up a free, no-obligation chat between you and them today.