Repaying an interest-only mortgage

Interest-only mortgage productions originated as a niche offering. They were aimed at a small portion of homeowners but became increasingly popular in the late 20th century as homeowners struggled with steeply rising inflation and interest rates.

If you’re one of the 600,000-plus homeowners who current have an interest-only mortgage, or you’re considering switching to an interest-only mortgage, this guide will answer some common questions.

notepad with text saying interest-only mortgage and set of house keys

In this guide

What is an interest-only mortgage?
How does an interest-only mortgage work?
Interest-only mortgage criteria
Interest-only or repayment mortgage – which is best?
What are the advantages of an interest-only residential mortgage?
What are the advantages of a buy-to-let interest-only mortgage?
How common are interest-only mortgages?
Mortgage interest rates for interest-only mortgages – how much will I pay?
Mortgage calculator interest only – what will my monthly repayments be?
What happens at the end of an interest-only mortgage?
What if I can’t pay off my interest-only mortgage?
Should I downsize if I can’t repay my interest-only mortgage?
What if I don’t have enough equity to be able to downsize?
Retirement interest-only mortgages vs lifetime mortgages – which is best?

What is an interest-only mortgage?

An interest-only mortgage is a property loan that allows you to just pay the interest accrued each month. You don’t repay any of the loan itself until the end of the mortgage term.

How does an interest-only mortgage work?

With an interest-only mortgage, you will only pay the loan interest each month. This means your original loan amount stays the same throughout the mortgage term. At the end of your mortgage term, you will need to repay the entire mortgage loan.

For example, if you take out a £200,000 mortgage with an interest rate of 5%, you will pay £10,000 in interest each year you have the mortgage (5% of the loan). You will still owe £200,000 to your mortgage lender when the mortgage comes to an end.

There are several different strategies that can be used to repay the loan when your mortgage comes to an end.

Interest-only mortgage criteria

Borrowing criteria for an interest-only mortgage will differ from lender to lender, but there are some common guidelines. These guidelines mean that interest-only mortgages are only suitable for a relatively small number of homeowners.

Maximum loan to value (LTV)

Most mortgage companies will lend a maximum of 50-60% of the value of the property on an interest-only mortgage, though some will go as high as 75% if they’re satisfied that it doesn’t present too great of a risk to them. This means you’ll need a deposit of at least 25%, but more likely closer to 50% of the value of your property.

Minimum income

Most lenders will require a minimum income of £75,000 for a single applicant or £100,000 for joint applicants.

Minimum equity in property

Most lenders will require you to have a minimum of £200,000-£300,000 equity in your property to consider an interest-only mortgage.

Interest-only or repayment mortgage – which is best?

Interest-only mortgages and repayment mortgages are quite different products that suit different circumstances.

Although monthly payments are lower on interest-only mortgages, they are more expensive than repayment mortgages overall. This is because you pay interest on the whole loan amount throughout the entire mortgage term. With a repayment mortgage, the amount you’re paying interest on reduces as you pay off the capital loan.

The main thing to consider if you’re thinking about taking out an interest-only mortgage is how you plan to repay the loan when your mortgage comes to an end. Your lender will ask to see evidence of your repayment plan and will only approve the mortgage if they’re satisfied with it.

Example of repayment mortgage vs interest-only mortgage

Interest-only mortgage

Loan amount: £200,000

Loan term: 25 years

Interest rate: 5%

Total paid over term: £250,000 interest + £200,000 capital repayment = £450,000

Repayment mortgage

Loan amount: £200,000

Loan term: 25 years

Interest rate: 5%

Total paid over term: £150,754 interest + £200,000 capital repayment = £350,754

What are the advantages of an interest-only residential mortgage?

The main advantage of an interest-only residential mortgage is that it allows you to keep your monthly payments lower than a repayment mortgage. Using the mortgage example above, an interest-only mortgage would mean monthly payments of £833.33 versus £1,169 on a repayment mortgage.

What are the advantages of a buy-to-let interest-only mortgage?

An interest-only buy-to-let mortgage is often more appealing to investors than a repayment buy-to-let mortgage. Interest-only means monthly overheads are kept low and the capital loan can be repaid when they sell the property.

This strategy, however, relies on property prices being robust. Unfortunately, many buy-to-let investors have been caught out by this strategy in times of economic fluctuation. This was particularly an issue in the late 1980s/early 1990s, after the economic downturn in 2007/2008, and more recently in the wake of the Covid pandemic.

How common are interest-only mortgages?

You may be surprised how many homeowners are currently on interest-only mortgages. According to recent figures, 9% of all UK mortgages are interest-only.

Mortgage interest rates for interest-only mortgages – how much will I pay?

Interest rates for interest-only mortgages are similar to repayment mortgages, typically 4-5% at the moment.

Mortgage calculator interest only – what will my monthly payments be?

It’s fairly easy to calculate interest-only mortgage payments.

You can work out the interest that will be payable each year and divide that amount by 12 to calculate your monthly payment. For example, if your mortgage interest rate is 5% and you’ve borrowed £200,000, you’ll need to do the sum:

£200,000 x 5% = £10,000

You will be required to pay £10,000 in interest each year. This will result in monthly mortgage payments of £833.33 (not including any product fees added to your loan).

What happens at the end of an interest-only mortgage?

Interest-only mortgages are usually repayable after a maximum term of 25 years or at the point of retirement, whichever happens first.

When your mortgage term comes to an end, you will need to repay the loan. There are several ways you can do this, including:

Take out a new mortgage (this might be a repayment loan or another interest-only product)
Pay off the mortgage loan with savings or investments
Sell the property to repay the loan

What if I can’t pay off my interest-only mortgage?

If things haven’t gone to play and you find you’re unable to pay off your interest-only mortgage, you can either sell your house or try to find a new mortgage product.

Should I downsize if I can’t repay my interest-only mortgage?

If you’ve got a reasonable amount of equity in your property, your best financial option may be to sell your current property and downsize to a smaller home using the equity. If this is an option for you, it would leave you better off financially as you’d have no monthly payments. You’d also have nothing to repay at the point of selling your next home.

What if I don’t have enough equity to be able to downsize?

If you’ve reached retirement age, your options will be limited. There are two retirement mortgage products that may be available to you: a retirement interest-only mortgage (known as an RIO mortgage) or a lifetime mortgage. If you don’t quality for either of these products, your only option is likely to be to sell your current property, repay your mortgage loan and move into a rental property.

Retirement interest-only mortgages vs lifetime mortgages – which is best?

Retirement interest-only mortgages are very similar to normal interest-only mortgages but is aimed specifically at homeowners in retirement. With retirement interest-only mortgages you will pay interest on the loan amount but the capital will not need to be repaid until the property is sold. This means you can stay in your current property either until you die or until you need to move into residential care.

A lifetime mortgage also allows you to stay in your property, but you can choose whether you repay any interest or not. If you choose not to pay any interest it will build up throughout the mortgage term. At the point of selling the property both the initial mortgage loan and the interest will be payable in one lump sum.

It’s important to note that interest rates of lifetime mortgages tend to be higher than other mortgages. Lifetime mortgages often have interest rates of 7-10%. If you choose not to make any interest payments over the course of your lifetime mortgage, your loan will acquire compound interest. This means the amount added to the loan each year is not just interest on the original loan amount, but interest on the original loan amount plus the interest that has already been accumulated. This means the amount you owe can increase very quickly.

Example of lifetime mortgage compound interest accumulation

If you were to borrow £200,000 on a lifetime mortgage with an interest rate of 7%, and chose not to pay any interest until the end of the term, you could find yourself owing almost double your original loan amount (more than £390,000) after 10 years. It’s important to note that you will not be liable for more than the property is worth, but you could be left with no equity in your property. This is something to consider if the idea of leaving an inheritance is important to you.

Because compound interest on a lifetime mortgage accumulates so quickly, lifetime mortgage lenders are very cautious about how much they’re prepared to lend. For example, on a property worth £400,000 you’re unlikely to be able to borrow more than £160,000. How much a lifetime mortgage company will lend you will depend on your age, property value and medical history.

If you’re coming to the end of an interest-only mortgage and want to explore your options, Quick Move Now could provide a quick and guaranteed cash sale. Call our friendly, helpful team on 0800 068 3366 for a free, no-obligation cash offer.

Paying off an interest-only mortgage