The two main ways to pay off a loan balance are interest-only and repayment mortgages. But which one is best suited to you?
The difference between repayment and interest-only mortgages
A repayment mortgage is when your monthly repayments go towards clearing your mortgage balance, as well as paying the interest owed on it. That means you’ll own your property outright once your mortgage is paid off.
On the flipside, with an interest-only mortgage, your payments only go towards the interest on your mortgage, and don’t reduce the total amount you owe.
At the end of the mortgage term, you will need to repay the whole balance using savings, inheritance, pension withdrawal or sale of property.
A £150,000 loan at 5% over 25 years would cost £625 per month interest-only, but £877 per month as a repayment mortgage.
But at the end of the 25 years, if you took out an interest-only loan, you would still owe £150,000, whereas the repayment mortgage would have cleared the debt; and you’d own the property outright.
Benefits of interest-only
The advantages of an interest-only mortgage include:
- Lower monthly payments
- More flexibility to choose where to invest your money
- You could make a profit if your investment pays off
If you’ll be accepted
Since the 2008 financial crisis, it has become very difficult to borrow on an interest-only basis, with strict criteria in place – such as a high deposit and a certain level of equity within the property. For example, they may require a deposit between 25%-80%.
They will also want you to provide evidence of an approved ‘repayment vehicle’, e.g. a proven way that you can pay off the capital at the end of the term.
Acceptable plans include if you have ISAs and stock market investments in place; or if you’re a landlord, and the property is a buy-to-let. In fact, it has become much more difficult, in recent years, to secure an interest-only mortgage on your own residential property. Most lenders will only accept an interest-only mortgage on a buy-to-let property, although this route is widely accepted.
Some lenders will allow the sale of this BtL mortgaged property to be an acceptable repayment source, because the equity may increase if the value of the property has increased.
How to pay off an interest-only mortgage
There are a number of ways to ensure that you pay off the capital at the end of the term. These include:
- Switching to a repayment mortgage. A mortgage advisor can help with this.
- Paying into an investment plan
- Making lump-sum overpayments, if your lender allows it.
If you are thinking of taking out an interest-only mortgage, then get in touch for a free consultation at your convenience – we’re available for appointments in Huddersfield, Halifax, Brighouse, Elland and further afield:
Approval number: Sol7762