When choosing a mortgage, you need to decide how the money you borrow will be repaid.
Two main options are repayment mortgages and interest-only mortgages.
With a repayment mortgage, your monthly payments gradually repay the amount borrowed.
With an interest-only mortgage, your regular payments mainly cover the interest. Therefore, you will still need to repay the original loan.
Understanding this difference is important before choosing a mortgage.
What Is a Repayment Mortgage?
A repayment mortgage is also known as a capital and interest mortgage.
Each monthly payment normally contains two parts:
Interest – the cost of borrowing the money.
Capital – part of the money you borrowed.
Therefore, your mortgage balance should gradually fall as you make the required payments.
If all payments are made as agreed, the mortgage should be repaid by the end of the term.
A Simple Repayment Example
Suppose you borrow:
£200,000
over:
25 years
Your monthly payments include both interest and capital.
At first, a larger part of each payment may cover interest.
However, as the mortgage balance falls, less interest is charged if the rate stays the same.
As a result, more of your payment can go towards the capital.
By the end of the mortgage term, the £200,000 should be repaid if everything goes according to the mortgage agreement.
Why Does the Balance Fall Slowly at First?
This can surprise new homeowners.
During the early years of a repayment mortgage, a large part of each payment can go towards interest.
Therefore, the balance may not fall as quickly as expected.
Over time, the balance becomes smaller.
As a result, less interest is charged if the rate remains the same. More of the payment can then reduce the capital.
What Is an Interest-Only Mortgage?
An interest-only mortgage works differently.
Your regular mortgage payments normally cover the interest charged on the loan.
However, they do not normally repay the original amount borrowed.
For example, suppose you borrow:
£200,000
on an interest-only basis.
After making the required interest payments for 25 years, you could still owe:
£200,000
Therefore, you need a separate plan to repay the capital.
What Is a Repayment Strategy?
Lenders normally require interest-only borrowers to have a suitable way of repaying the mortgage at the end.
This is often called a repayment strategy or repayment vehicle.
Depending on the lender, possible strategies may include certain:
- investments
- savings
- pensions
- other assets
- property sale plans
However, lenders have their own rules.
Therefore, a repayment strategy accepted by one lender may not be accepted by another.
Why Are Interest-Only Payments Lower?
Interest-only payments are usually lower because you are not regularly paying back the capital.
For example, imagine two people borrow the same amount at the same interest rate.
One has a repayment mortgage.
The other has an interest-only mortgage.
The interest-only borrower will normally have the lower required monthly payment.
However, the lower payment comes with an important difference:
The mortgage debt is not normally reducing.
Therefore, lower monthly payments do not mean the mortgage is cheaper overall.
A Simple Interest-Only Example
Suppose you borrow:
£200,000
at an interest rate of:
5%
A simple annual interest calculation would be:
£200,000 × 5% = £10,000
That is about:
£833 per month
This example is simplified.
However, it shows the basic idea.
You are paying the interest, while the £200,000 capital remains outstanding.
Repayment and Interest-Only Compared
The main differences can be shown simply:
| Repayment | Interest-Only | |
|---|---|---|
| Monthly payment covers interest | Yes | Yes |
| Monthly payment repays capital | Yes | Usually no |
| Balance normally falls | Yes | No |
| Repayment plan needed at the end | Usually no | Yes |
| Monthly payment | Usually higher | Usually lower |
| Capital left at end | Normally £0 | Original balance may remain |
This assumes all required payments are made and the mortgage runs as planned.
Which Mortgage Costs More Each Month?
A repayment mortgage will normally have the higher required monthly payment.
This is because you are paying both the interest and part of the capital.
In contrast, an interest-only payment mainly covers interest.
Therefore, it can look much cheaper each month.
However, you still need to repay the capital later.
Which Mortgage Costs More Overall?
This depends on the mortgage, rate, term and repayment strategy.
However, an interest-only mortgage can result in more mortgage interest being paid.
This is because the balance does not normally reduce through the regular payments.
For example, interest may continue to be charged on the full £200,000.
With a repayment mortgage, the balance gradually falls.
Therefore, there is less debt on which future interest can be charged.
What Happens at the End of a Repayment Mortgage?
If everything goes according to plan, the mortgage balance reaches zero.
You have then repaid the money borrowed and the interest charged during the mortgage.
Therefore, there should be no mortgage capital left to repay.
What Happens at the End of an Interest-Only Mortgage?
The situation is very different.
The original capital may still be outstanding.
For example, you could reach the end of a 25-year mortgage and still owe:
£200,000
The lender will expect this money to be repaid.
Therefore, your repayment strategy is very important.
What If Your Repayment Plan Does Not Work?
This is one of the main risks of an interest-only mortgage.
Suppose you expect an investment to grow enough to repay your mortgage.
However, it performs worse than expected.
You could face a shortfall.
Likewise, you may plan to sell a property. However, its value could be lower than expected.
Therefore, a repayment strategy should not simply be forgotten once the mortgage begins.
Review it regularly.
Can You Sell the Property to Repay the Mortgage?
Some lenders may accept the sale of a property as part of an interest-only repayment strategy.
However, there are risks.
Property prices can fall as well as rise.
Also, selling your home means you will need somewhere else to live.
Therefore, the lender may have rules about when a property sale is acceptable as a repayment strategy.
Can You Make Overpayments on an Interest-Only Mortgage?
Often, yes.
Overpayments can reduce the capital balance.
As a result, they may also reduce future interest costs.
However, the mortgage may limit how much you can overpay.
Early Repayment Charges may also apply.
Therefore, check the mortgage terms first.
Can You Make Overpayments on a Repayment Mortgage?
Yes, many repayment mortgages also allow overpayments.
For example, you may pay an extra amount each month or make a lump-sum payment.
This reduces the mortgage balance more quickly.
As a result, you may pay less interest and repay the mortgage sooner.
Again, check for limits and Early Repayment Charges.
Can You Change From Interest-Only to Repayment?
It may be possible.
Moving to repayment means your monthly payments will normally increase.
However, you will then start reducing the capital through your regular payments.
Your lender may need to check whether the higher payments are affordable.
Therefore, contact the lender if you want to change how your mortgage is repaid.
Can You Change From Repayment to Interest-Only?
This may also be possible in some cases.
However, lenders normally have stricter rules for interest-only mortgages.
You may need a suitable repayment strategy.
The lender may also have requirements for your income, equity or Loan-to-Value.
Therefore, changing to interest-only is not guaranteed.
What Is Part Repayment and Part Interest-Only?
Some mortgages can be arranged on a part-and-part basis.
This means part of the mortgage is repayment and the rest is interest-only.
For example:
Total mortgage: £200,000
Repayment part: £120,000
Interest-only part: £80,000
The repayment part should reduce over time.
However, the £80,000 interest-only balance will need a separate repayment plan.
This can provide a middle ground between the two options.
Are Interest-Only Mortgages Available to Homeowners?
Yes, but the lending rules can be stricter than for repayment mortgages.
The lender may consider:
- your income
- your Loan-to-Value
- your age
- your mortgage term
- your repayment strategy
- your financial position
Therefore, not everyone will qualify.
What About Buy-to-Let Mortgages?
Interest-only mortgages are common in the buy-to-let market.
A landlord may choose interest-only to keep the regular mortgage payment lower.
However, the capital still needs to be repaid.
For example, the landlord may plan to sell the property later.
This still carries risk because property values are not guaranteed to rise.
Does Loan-to-Value Matter?
Yes.
Loan-to-Value (LTV) compares your mortgage with the value of the property.
For example:
Property value: £300,000
Mortgage: £150,000
The LTV is:
£150,000 ÷ £300,000 × 100 = 50%
Lenders may set lower maximum LTV limits for interest-only mortgages.
Therefore, you may need more equity or a larger deposit.
What Are the Benefits of a Repayment Mortgage?
A repayment mortgage has one clear benefit:
Your mortgage balance should reduce over time.
This means you are gradually repaying the debt.
You also do not normally need a separate plan to repay a large mortgage balance at the end.
For many homeowners, this makes repayment mortgages easier to understand and manage.
What Are the Drawbacks of a Repayment Mortgage?
The main drawback is the higher monthly payment.
You are paying both interest and capital.
Therefore, the required payment is normally higher than with an equivalent interest-only mortgage.
This can affect affordability.
What Are the Benefits of Interest-Only?
The main benefit is the lower required monthly mortgage payment.
This can provide greater monthly cash flow.
Interest-only can also have uses in some forms of property investment.
However, the lower payment should not be confused with lower debt.
The capital still needs to be repaid.
What Are the Risks of Interest-Only?
The main risk is reaching the end of the mortgage without enough money to repay the capital.
For example, your:
- investments may underperform
- savings may be too small
- property may fall in value
- circumstances may change
Therefore, interest-only mortgages need careful long-term planning.
What If Interest Rates Rise?
Both repayment and interest-only mortgages can be affected by higher rates.
The effect depends on whether your mortgage rate is fixed or variable.
However, interest-only borrowers can be particularly exposed because the full capital balance may remain outstanding.
Therefore, higher rates can increase the interest charged on a large balance.
Is Interest-Only Cheaper?
Not necessarily.
It is normally cheaper each month, but that is not the same as being cheaper overall.
With a repayment mortgage, you are gradually paying off your debt.
With interest-only, you still need to find the money to repay the capital.
Therefore, compare the full long-term cost.
A Simple Comparison
Suppose two borrowers each take a £200,000 mortgage.
Borrower A – Repayment
The monthly payment covers:
Interest + capital
Therefore, the mortgage balance gradually falls.
Borrower B – Interest-Only
The monthly payment mainly covers:
Interest
Therefore, the £200,000 capital may remain outstanding.
Borrower B has lower required mortgage payments.
However, Borrower B also needs a plan to repay the £200,000.
That is the key difference.
Questions to Ask Before Choosing
Before choosing how to repay your mortgage, consider:
Can I afford the repayment mortgage payment?
How important are lower monthly payments?
If I choose interest-only, how will I repay the capital?
What happens if that repayment plan performs badly?
Could I afford higher payments if interest rates rise?
How long will the mortgage last?
These questions can help you understand the risks.
The Key Point
The difference between repayment and interest-only mortgages is simple.
With a repayment mortgage, your monthly payments gradually repay both the interest and the amount borrowed.
With an interest-only mortgage, your regular payments normally cover the interest, while the capital remains to be repaid separately.
Therefore, do not choose interest-only simply because the monthly payment looks cheaper.
The important question is:
How will the mortgage itself be repaid?
For many borrowers, a repayment mortgage provides a clear route towards owning their home without a mortgage at the end of the term.
Interest-only can be suitable in some circumstances. However, it needs a realistic and carefully managed plan for repaying the capital.