What is an Interest Only Mortgage?
With an interest only mortgage, your monthly payments only cover the interest on the loan. You don't pay off any of the original amount borrowed (the capital) during the mortgage term. At the end, you still owe the full amount you borrowed.
Example: Borrow £200,000 over 25 years at 5%. Repayment mortgage: £1,169/month. Interest only: £833/month. You save £336/month BUT after 25 years you still owe £200,000.
Why Choose Interest Only?
The lower monthly payments can be attractive, and for some strategies it makes financial sense.
Reasons people choose interest only:
- Lower monthly outgoings
- Buy-to-let investors (plan to sell property to repay)
- People expecting a future inheritance
- Those with other investments growing faster than mortgage interest
- Temporary measure while income is reduced
- Part of retirement planning with planned downsizing
Repayment Vehicles
Lenders need to see a credible plan for how you'll repay the capital at the end. These are called 'repayment vehicles'.
Acceptable repayment vehicles:
- Sale of the mortgaged property (BTL only usually)
- Sale of another property
- Investments (ISAs, shares, bonds)
- Pension lump sum
- Endowment policies (less common now)
- Inheritance (some lenders)
Lenders will want evidence your repayment vehicle is realistic. 'I'll figure it out' isn't a repayment strategy. Many people from the 1980s-90s endowment mortgage era found this out the hard way when their plans fell short.
Interest Only for Residential Mortgages
Getting an interest only residential mortgage is harder than it used to be. Most lenders now require a minimum loan amount (often £75,000-£300,000) and a maximum loan-to-value (often 50-75%).
Interest Only for Buy-to-Let
Interest only is much more common for buy-to-let mortgages. The plan is usually to sell the property at the end of the term to repay the loan, hopefully at a profit after capital appreciation.
Consider a part-and-part mortgage: some of your payment covers interest only, some is repayment. This gives lower payments than full repayment while still reducing the balance over time.