How Do Interest-Only Mortgages Work?
In essence, UK interest-only means that you borrow a sum to purchase a property, but only pay interest on that loan without repaying any of the original amount.
At the end of the term, the original loan amount becomes payable.
Interest-only lending is often considered cheaper since the monthly charges are lower - because you're only paying the interest element of the loan.
However, it is vital to remember that the original loan still needs to be repaid. When taking out an interest-only mortgage, you will need to demonstrate your repayment strategy.
How Do Repayment and Interest-Only Mortgages Compare?
Repayment mortgages are more typical for a residential property purchase. The monthly repayment includes a part of the original loan, plus the interest payable.
Over time, the proportion of your monthly repayment assigned to capital goes down, as you repay the lending gradually.
The downside is that your monthly payments are higher, but the positive is that you will repay the mortgage over time, without a steep repayment falling due at the end of the term.
What Repayment Plans are Acceptable For Interest-Only Mortgages?
Before a lender approves your application, they're going to need to know how you plan to repay the balance.
This is called an exit strategy or a repayment vehicle - and is usually another asset or an investment that is worth enough to repay the original lending amount.
Lenders will need to see evidence of this - such as an asset valuation.
Common repayment strategies include:
- Using savings or an ISA.
- Cashing in investments or selling stocks.
- Selling another portfolio property.
- Remortgaging the borrowing.
What Deposit Do I Need for an Interest-Only Mortgage?
Interest-only mortgages are less common than repayment loans, and so you are bound by the criteria of the smaller number of lenders who offer this product.
Deposit values tend to be around 25%. Some niche providers will accept lower deposits as little as 15%, but this depends on meeting all other lending criteria.
How Do Repayments and Deposits Compare Between Interest-Only and Repayment?
Here is an overview of the primary differences, and how that impacts the mortgage repayment and criteria:
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Interest-Only
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Repayment
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Minimum deposit
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15%
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5%
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Repayment value
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Just the interest charged
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Interest charge plus an element of capital
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Balance at the end of term
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Full original loan value
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Zero
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Monthly interest calculation
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Full loan balance
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Remaining loan balance
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Risk factors
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Repayment strategy is vital - with the risk of repossession
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Failure to keep up with repayments can lead to repossession
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Other comparable
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Lower monthly cost, popular with investors to avoid tying up cash in the property.
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Growth in equity over the mortgage term.
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What are the Benefits to an Interest-Only Mortgage?
The key benefit is that you pay less per month - but the biggest downside is that you must have a repayment vehicle that will cover the full original loan balance when the mortgage term ends.
- Monthly repayments are lower. If you borrowed £200,000 interest-only, at 3% interest and over 25 years, you'd pay £500 per month. The same loan on a repayment basis would cost £948 a month.
- Investment viability - as an interest-only mortgage, you can free up other assets or cash to expand your portfolio, only needing to release an asset when the term ends.
- Profitability scope - stable repayment vehicles that grow in value may mean that you are left with an excess amount once the capital is repaid. One option is to make optional additional payments to reduce the capital balance over time.
Are There any Pitfalls to Interest-Only Mortgages?
As with any lending, there are pros and cons to consider:
- Increased expense. Over a mortgage lifetime, you will pay more interest, since the capital balance never reduces.
- Full repayment is essential - you need to know how you're going to repay the original loan balance, at risk of repossession if your repayment strategy falls through.
What are the Average Interest Rates on Interest-Only UK Mortgages?
Most UK lenders will offer somewhat similar rates on interest-only lending as they do on repayment mortgages.
The critical criteria are being able to pass eligibility assessments and provide a viable repayment strategy.
In most cases, the LTV ratio available will be lower, so you'll need a more significant deposit.
What Happens if My Interest-Only Mortgage Ends and I Can't Repay the Balance?
As you reach the end of your mortgage period, you should take action to ensure your exit strategy remains viable.
If you cannot repay the debt at the end of the term, there are a few options available:
- Requesting a mortgage extension from your current provider.
- Downsizing, by selling the property and retaining the difference between the sale value and the loan balance owing.
- Selling a portfolio property to raise the repayment funds.
- Cashing in an investment, withdrawing funds from a pension pot, or using savings.
- Remortgaging on a repayment mortgage plan.
- Using an equity release product to refinance.
What Other Eligibility Factors Impact an Interest-Only Mortgage Application?
Lenders will look at several eligibility factors to determine whether they can offer you an interest-only mortgage.
As well as residential lending, multiple other interest-only products are available depending on the nature of your property purchase:
- Buy to Let Interest Only Mortgage. Landlords often use interest-only BTL lending, with the strategy to sell the property at a profit at the end of the loan term.
- Lifetime Interest-Only Mortgages. Lifetime mortgages are available to homeowners aged 55+. This equity release product is secured against your property, with interest either paid as you go or added to the total owing and recouped by selling the property when the homeowner passes away or goes into care.
Key criteria include:
- The location of the property - interest-only is more common in London and Scotland, often because of the cost of the property market. Properties in some areas may be easier to mortgage this way due to the availability of local lenders.
- Your income, viability of your repayment strategy, the Loan to Value ratio, your age, and personal financial situation.
Can I Get an Interest-Only Mortgage if I Have Bad Credit?
Potentially - although you will have fewer lenders to choose between.
Lenders will look at what bad credit issues you have experienced, when they occurred, and the severity of the circumstances.
Specialist bad credit lenders can offer lending to applicants with late payments and defaults through to bankruptcy and repossession history.
Contact the Revolution Finance Brokers team for more advice about interest-only borrowing with bad credit.
Can Interest-Only Mortgages be Refinanced?
Indeed they can - provided you meet the lender eligibility requirements, you can refinance either into another interest-only loan or through another mortgage product.
Independent Advice from Interest-Only Mortgage Experts
For more advice on UK interest-only mortgages, contact Revolution Brokers.
As independent whole-of-market interest-only experts, our team ensures you receive impartial advice and access to the best deals on the market.
