Interest Only or a Repayment Mortgage. Which one would be the most suitable for you?Hi if we haven’t met before, my name is Dan, I am a CeMAP qualified mortgage & protection adviser. This video is purely for educational purposes only, and should not be seen as advice or a recommendation to act and I must stress your home may be repossessed if you do not keep up with the repayments on the mortgage.
With that out of the way, on with the video.
The two main ways to pay your mortgage are interest only and repayment, also known as a capital repayment. In this video, I will hopefully give you the basics to help you decide which is best suited for your needs but I do strongly recommend speaking to a qualified mortgage adviser, such as myself before making this decision.
So what is an Interest Only mortgage?Your monthly repayments only go towards the interest on your mortgage, this means you will not be reducing the balance of the mortgage. This means the repayments will be lower each month, but you will still owe the same amount at the end of the term as when you initially took out the mortgage.
You will need to repay the whole balance at the end of your mortgage term to own the property fully.
You can do this in several ways.
You can use a repayment vehicle, such as any kind of savings plan like an ISA, investment fund, or pension. Using a lump sum you get before the mortgage ends, like an inheritance or pension withdrawal.
You could also choose to sell the property to pay back what you owe to your lender.
Whilst these are some of the ways you can repay back the capital owed to the lender at the end of the term, they aren’t all necessarily acceptable. So, you will need to check with the mortgage lender before applying.
So what is a Repayment mortgage?With a repayment mortgage, when you make the monthly mortgage payments, part of the payment goes towards clearing some of the mortgage balance as well as paying the interest owed on it.
The amount you pay each month is calculated so that you pay off the full amount owed by the end of the mortgage term. Mortgage terms typically range between 5 years to 40 years and the maximum term available to you can get depend on your age and also whether you have acceptable income to support the mortgage into your retirement.
I must stress that the longer the term of the mortgage, the more interest you will pay back and this applies to both Interest Only and Repayment mortgages.
One of the benefits of a repayment mortgage is you will own your property outright at the end of the term.
So which is better? Interest Only? Or Repayment?This entirely depends on you, your circumstances, and your needs.
The advantages of repayment mortgages are:
You pay less interest overall because what you owe decreases every month. Towards the end of the mortgage’s term, more of each payment goes towards clearing the balance.
Another benefit is you may have the option to apply for lower interest rates later in the mortgage term because there can be cheaper rates available once your outstanding balance is smaller. However I may add that for the majority of lenders, once your loan to value drops anywhere below 50% or 60% then the rates will remain the same.
You will own your home at the end of the mortgage term if you make all of your repayments.
However a negative can be, the monthly repayments will be higher than if you get an interest-only mortgage, so make sure you will be able to afford them.
The advantages of interest-only mortgages are:Lower monthly payments because they only cover the interest. More flexibility to choose where your money goes. You can decide how you will save to pay back the mortgage balance.
You could make a profit if your investments perform well as you could save up enough to pay off your mortgage more quickly.
The disadvantages of interest-only mortgages are:It is usually more expensive overall because the amount you owe will not decrease over the mortgage term. This means that the amount of interest you pay will not go down either unless you get a deal with a lower interest rate.
They can be more complicated to look after because your mortgage and the repayment vehicle may be separate. They are riskier than repayment mortgages if your repayment vehicle performs badly because if your repayment vehicle relies on investments, pension funds, an inheritance, or a rise in house prices, it may not make enough to pay off your mortgage.
So which is the cheapest?As I have already mentioned, Repayment mortgages typically cost less overall but come with higher monthly repayments than interest-only mortgages. For example, if you took a mortgage for £160,000 at 4% for 25 years the monthly payment is around £843 per month on a Repayment mortgage but around £533 on Interest only.
On Interest Only you will pay £159,999 in interest over the 25 years with a 4% rate and owe the original £160,000 that you borrowed which will mean you would have paid £319,999.
Whereas on a Repayment mortgage, you pay around £253,124 in total, of which £93,124 is the interest, with the remaining £160,000 being the capital that you owed.
Choosing which one is right for you.Interest-only mortgages do not suit most borrowers. Only get one if you are aware of the risks and have a repayment plan to save enough capital by the end of the term.
You would need to be able to make a profit from your investment vehicle and preferably have a backup option to help you pay off the mortgage.
You can get a mortgage split between repayment and interest only, which is known as “Part & Part”. This is where part of your mortgage balance is on an interest only basis and the other part is capital payment with an element of interest.
Your balance will go down every month but there will still be an amount left to pay at the end of the mortgage term on part of the mortgage that you have on interest only.
Interest Only mortgages can be complicated, and also difficult to obtain if you’re applying for a mortgage on a residential property. This is why I would strongly recommend you speak to a mortgage adviser before opting for an Interest-Only mortgage.
You need to think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage or any other debt secured on it.
I appreciate that is a lot of information to take in, please feel free to ask me any questions in the comments below. If you’d like my help obtaining a mortgage, please feel free to contact me.