Interest Only and Repayment Mortgages Explained

There are two main ways to pay off your mortgage balance:

  • Interest-Only Mortgage
  • Repayment Mortgage

An interest-only mortgage is a popular way to borrow money to buy an asset that won’t go down in value much. You are only ever paying back the interest, not the loan itself.

With a repayment mortgage, you pay off not just the interest, but also the loan itself, so that at the end of the mortgage term, you will own your home outright.

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Interest Only Mortgage Explained

With an interest-only mortgage, your repayments are lower, but you will still owe the same at the end of the term as when you took out the mortgage.

If you want to own the property outright by the end of your mortgage term, you will need to have paid the whole balance. You can do this by:

  • Using a repayment vehicle such as an ISA, investment fund or a pension
  • Use a lump sum payment

This is an option often chosen by buy-to-let investors because it’s the cheapest kind of mortgage. It can be risky though, as you’re relying on property prices which can go down as well as up.

Advantages of Interest Only Mortgages

  • Lower monthly repayments – as you only cover the interest owed each month
  • More flexibility – You have more say over where your money goes. You can decide how you will save to pay back the mortgage balance. This can give you more money for other things, such as home improvements
  • Profit could be made – If your investments perform well, you could save up enough

Disadvantages of Interest Only Mortgages

  • More expensive overall – As the amount you owe will not decrease over the mortgage term, the amount of interest you pay will not go down either
  • Complicated mortgage management – As your repayment vehicle and mortgage are two separate things, this can lead to complications
  • Risky – If your repayment vehicle performs badly

Repayment Mortgage Explained

If you go with a repayment mortgage, you make monthly payments that go towards clearing some of the balance, as well as the interest payments owed on it.

The amount you pay each month is calculated so you pay off the full amount owed by the end of the mortgage term. Terms usually last around 25 years and once the mortgage is paid off you’ll own the property outright.

Repayment mortgages cost less overall, but they do come with a higher monthly repayment than an interest-only mortgage.

Advantages of Repayment Mortgages

  • Pay less overall – What you owe each month will decrease over time, though later in the mortgage term, a larger portion of each payment will go towards clearing the balance
  • You will own your own home – Once you have made all your payments then the property is yours to own outright
  • Lower interest rates – Later in the mortgage term you can get better deals once your mortgage balance is lower

Disadvantages of Repayment Mortgages

  • You might need a new mortgage – If you decide to move house again early on in the mortgage term, then you’ll have only paid off a small amount of the balance, so it’s likely that you’ll need a new 20/25-year repayment mortgage to make monthly payments manageable
  • Little capital is repaid – In the early years of the mortgage term, you’ll mainly be paying off interest payments in your monthly payment.

How Simpson Millar Can Help You

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