Interest only v repayment mortgages – Quick Move Now takes a look…

When deciding what mortgage you want people usually start by questioning the relative merits of a tracker or fixed rate. But more imperative is the basic question of should you choose an interest-only or a repayment mortgage? They both very much do what they say on the tin.

If you take out an interest-only mortgage, you will pay only the interest you owe that month. If you opt for a repayment mortgage, you will pay the monthly interest, plus a little extra, gradually chipping away at the capital you owe.

The use of interest-only mortgages declined considerably for some time after endowment policies, taken out to cover the final capital costs, largely failed to reach the required amount.

But they are returning and Geoff Knappett, of Newbury Building Society, says they do have a place in the market, if they are used for the right reasons.

They got a bad name because people used them for affordability reasons, which was the wrong thing to do. People think that they will be able to repay the capital with an inheritance or by down-sizing, but neither of these are guaranteed. Unless people can afford a repayment mortgage, we are unlikely to give them an interest-only option.

There are times when interest-only mortgages are the best option, for example if someone has other assets which can be realised in a few years, or for buy-to-let mortgages. They could also be helpful to newly qualified professionals, who have good earning potential in the future. Or they tend to be taken out at the top end of the market and are low loan values against high value homes.

For many it is a clear cut choice. Some need the lower monthly repayments that an interest-only mortgage can offer, while others will require the certainty given by the repayment option.

Quick Move Now looks at some of the key points surrounding each, so you can make an informed judgement about what is best for you.

Interest only mortgage

  • Lower monthly payments mean it is cheaper to get on the housing ladder – but it may be more expensive in the long run
  • You must set up an additional investment to cover the final capital payment and keep a check that it will meet the required amount. This additional investment could return a much higher amount than necessary and therefore leave you with a lump sum as well as a house.
  • But there is an element of risk and, on the flip side, the investment may not even reach the amount required to pay off the capital on the mortgage
  • This type of mortgage is more sensitive to interest rate changes, meaning monthly payments could fall by a larger amount than a repayment but will also increase more considerably too
  • Some mortgage lenders are making it much harder to take out interest-only and may require larger deposits and proof of another investment
  • It is easier to fall into negative equity

Repayment mortgage

  • A safer and easier to manage option
  • But monthly payments are higher
  • At the end of the mortgage term you will own your house
  • You will actually end up paying less interest over the whole term; as the capital reduces so does the interest
  • No need to take out additional investments
  • Because you are always reducing the capital amount of the mortgage it is harder to fall into negative equity

Whichever route you decide to follow, always remember that you can change throughout the term of your mortgage. These are just some pointers to help you on your way, but always speak to a financial or mortgage advisor before making any final decisions.

This content was written by Quick Move Now
Published on 21st August 2013
Last updated on 20th April 2017

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