What is an Interest-Only Mortgage?

What is an interest-only mortgage?

An interest‑only mortgage is a type of home loan where your monthly payments cover only the interest charged by your lender. The amount borrowed does not reduce over time. At the end of the mortgage term, the full loan amount remains outstanding and needs to be repaid in a single payment.

This differs from a repayment mortgage, where monthly payments contribute towards both the interest and the loan amount.

How interest‑only mortgages work

When you take out an interest‑only mortgage, your lender charges interest on the amount borrowed. Your monthly payments cover only this interest, meaning your instalments will be lower than those on a repayment mortgage. With an interest-only mortgage, you’re not reducing the loan balance, so you'll have to repay the full amount at the end of your term.

For example, if you borrowed a sum of £150,000, you would still need to repay the £150,000 in full at the end of your mortgage. Many homebuyers may choose to repay the capital via ISAs, savings, bonds and shares, regular savings plans or by selling a second property.

What lenders typically require

Lenders usually require evidence of a clear plan to repay the loan amount at the end of the mortgage term. This may include:

• A repayment strategy, such as savings, ISAs or investments

• Evidence of anticipated lump‑sum payments, such as bonuses

• Equity held in other properties

• Plans involving the sale of the mortgaged property

• Evidence of retirement income where the mortgage extends into later life

• Confirmation that the chosen strategy is likely to cover the full loan amount

Pros and cons of interest‑only mortgages

Interest‑only mortgages can offer certain benefits, but they also come with potential drawbacks, so you may want to weigh up all the options before deciding on a type of mortgage.

Pros of interest‑only mortgages

Interest‑only mortgages can offer advantages such as:

• Lower monthly payments: Monthly payments will be lower than those of repayment mortgages, as they cover interest only

• Buy to let usage: Interest‑only mortgages are frequently used for buy to let properties, where rental income may be used to cover interest costs

• Switching options: Some lenders allow borrowers to move from an interest‑only arrangement to a repayment mortgage during the term, subject to eligibility and lender criteria

Cons of interest‑only mortgages

There may also be some disadvantages to interest-only mortgages, which could include:

• Long‑term cost: Because the loan balance remains unchanged, interest continues to be calculated on the full amount borrowed, which can result in higher overall interest costs compared with repayment mortgages

• End‑of‑term repayment: The full loan amount remains due at the end of the term. Lenders generally require evidence of a repayment plan before approving this type of mortgage

• Property value risk: If property prices fall, the value of the property is more likely to be lower than the outstanding mortgage balance, which can affect remortgaging or sale options

• Limited availability: Fewer lenders offer interest‑only mortgages, and eligibility criteria may be more restrictive. Typically, a significant deposit of around 25% may be required

Who is an interest‑only mortgage suitable for?

An interest‑only mortgage might be appropriate for those who:

• Have a reliable capital repayment strategy

• Expect to receive a lump sum in the future

• Have significant savings or investments

• Are purchasing a buy-to-let property

• Are comfortable managing long‑term financial planning

Interest‑only vs repayment mortgages

There are some key differences between interest-only and repayment mortgages.

Common misconceptions about interest-only mortgages

Our mortgage expert Terry Higgins outlined some common misconceptions about interest-only mortgages:

‘Lower monthly payments on interest‑only mortgages can give the impression that they cost less overall. However, because the loan balance doesn’t reduce, the total interest paid over the full term can be higher.

Interest-only mortgages can play a valuable role for certain borrowers, depending on their individual circumstances and financial goals. For some, the lower monthly payments offered by interest-only mortgages can provide greater flexibility and free up funds for investments or other priorities. With the right financial planning and advice, interest-only mortgages can be a great option for some people – but it’s always wise to ensure borrowers understand both the benefits and the challenges.’

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