Buying a house is an exciting time, but there’s a lot to think about and consider. Purchasing property is likely to be one of the biggest investments that you’ll make.
One key decision during the process is how you’re going to repay your mortgage. For mortgages, there are two options: an interest-only or a repayment mortgage.
Take a look at our guide below exploring the different options and comparing the advantages and disadvantages.
What is an interest-only mortgage?
An interest-only mortgage allows you to pay only the interest charged on a monthly basis for the term of the loan.
This means that you won’t have to repay the amount you’ve borrowed until the end of the term. But, when the term ends, you still owe the original amount you borrowed from the lender
The main benefit of choosing this mortgage is that the monthly payments will be low each month.
- Allows you to control your investments – as the monthly payments are low each month, it allows you to decide how to save to repay the capital, or putting money aside for home improvements
- Opportunity to profit – if you have chosen an investment vehicle that performs well, you may also end up with additional funds after you’ve made that final payment on your mortgage
- More expensive – in comparison to a repayment mortgage where the interest decreases over time, with an interest-only mortgage the capital isn’t shrinking and therefore you pay interest on the full amount
Typically, most borrowers avoid interest-only mortgages unless the lender is confident you have enough savings to pay off the capital.
Sometimes, if you’re a buy-to-let investor, then this type of mortgage is ideal – this is because it is assumed that the property will be sold to repay the mortgage and the mortgage interest can be offset against rental income for tax purposes. In this case, it makes sense to pay the full amount of interest on the debt to maximise the amount of tax you can offset.
What is a repayment mortgage?
A repayment mortgage is where you pay back a small part of the loan and the interest each month. When you reach the end of your term, you’re guaranteed to pay off the whole amount, assuming that you make all your payments.
The main benefit of choosing this mortgage is that you pay less interest overall, allowing you to build equity as you pay off the capital borrowed. It also gives us peace of mind, assuming that you keep up with your repayments, you’re guaranteed to own the home at the end of your mortgage term.
The only downside is that you’ll be paying a higher monthly repayment each month as you’ll be paying off both the capital of your loan and the interest.
What is the difference between them?
The main difference between an interest-only mortgage and a repayment mortgage is the approaches in how (and when) you pay them back to the lender.
With an interest-only mortgage, the monthly payments will be much cheaper than a repayment loan. This can make a mortgage more affordable for a borrower, however, in say 25 years’ time, they will still owe the lender the exact amount borrowed initially. That’s where it’s important to have a clear saving or investment plan ready for that eventual time.
There are a few different options available for paying back an interest-only mortgage.
How can you pay off an interest-only mortgage?
An interest-only mortgage can be paid off in a variety of different ways.
- Switch or remortgage to a repayment mortgage – this will mean your monthly payments increase but by the end of the term, the mortgage will be paid and you’ll own the property
- Pay into an investment plan or savings account – this pot can then be used to pay off the capital at the end of the term
- Make overpayments in large chunks (if allowed) – depending on the lender, you can pay off the capital in large sums. This is particularly useful if you are paid a large annual bonus and this can then be used to pay off your mortgage over time.
- Sell the property – if you have this type of mortgage and you can’t repay the amount you’ve borrowed at the end of your term, then you’ll likely need to sell the property to pay off the mortgage
Why choose an interest-only mortgage?
We’ve explained the difference between both a repayment mortgage and an interest-only one, but why would you choose an interest-only mortgage?
This type of mortgage is ideal for borrowers who are well-disciplined and able to either make periodic payments or have a good investment plan and strategy in place.
This mortgage type would also suit buy-to-let investors as it means lower outgoings.
Contact Robin Mortgage Design
If you are looking for a mortgage, no matter where you’re based, whether it’s in Milton Keynes, Crowthorpe or Essex, you will want to discuss your options with a mortgage broker first before you start looking for a house.
We hope this short article gives you hope and if you would like to discuss your options with a human being, then our team of professional mortgage advisers at Robin Mortgage Design would be happy to help. Just give us a call on 0333 242 386, alternatively, you can fill out our online enquiry form, and we’ll be in touch with you shortly.