What is an interest-only mortgage?
Interest-only mortgages work differently to standard repayment mortgages. Find out what an interest-only mortgage is and how it works.
How does an interest-only mortgage work?
With an interest-only mortgage, you will make monthly mortgage payments that only cover the interest on your mortgage. This means your monthly payments will be lower throughout the mortgage term, although you will still be expected to pay back the total loan amount in full.
You will either need to have the money set aside to pay off the rest of the mortgage when it ends or have a sufficient repayment vehicle lined up. Before you get an interest-only mortgage you’ll need to show lenders how you plan to pay back the loan.
Interest-only mortgages are a bigger risk to mortgage lenders, so there are strict guidelines to make sure you only get an interest-only mortgage if it’s right for you.
Some high street lenders and some smaller firms offer interest-only mortgages. They'll often need a house deposit or equity of at least 25%.
Interest-only vs. repayment mortgages
Here are the key differences between interest-only mortgages and repayment mortgages.
With an interest-only mortgage you:
only pay back the interest
pay the rest of what you borrowed at the end of the mortgage term
With a repayment mortgage you:
pay part of the loan and the interest back each month
will have paid everything back at the end of the term if you’ve made all your payments
So, if you borrowed £150,000, over 25 years at an interest rate of 4% you’d pay:
£500 a month with an interest-only
£791 a month with a repayment mortgage
With interest only, you’d still owe the £150,000 at the end of the mortgage term.
Types of interest-only mortgages
A fixed-rate interest-only mortgage means you will only pay a fixed amount of interest-only repayments for a set period of time. This is good for stability and helps you plan your finances.
At the end of the initial fixed period, you’ll go back to the standard variable rate (SVR). This could mean your payments go up but you can remortgage to see if you can find a more suitable deal.
Tracker mortgages follow The Bank of England’s base rate, and mortgage lenders set the overall rate just above the BoE's base rate accordingly. As such, the amount you pay per month will rise and fall in line with the BoE base rate.
Interest-only tracker mortgages are available from certain mortgage lenders. You can use our mortgage comparison tool to identify which lenders offer interest-only trackers relevant to your circumstances.
An offset mortgage links your mortgage loan to a savings account.
You do not accrue interest on your savings, instead, they go to offset the amount of your mortgage. So, the more you save, the less interest you pay on your mortgage.
For example, if your mortgage was £100,000 and you had a savings account of £20,000, you would only pay back interest on £80,000.
You can also put the money in your savings account and use it to pay off the capital at the end of the term.
Retirement interest-only mortgages let you borrow money against your property.
They’re good if you’re planning to downsize or remortgage.
Learn more about retirement interest-only mortgages.
Interest-only mortgage pros and cons
Interest-only mortgages have their advantages and disadvantages; here’s a breakdown of the pros and cons.
The pros of an interest-only mortgage:
you’ll pay less each month
It’s cheaper to get on the property ladder
you may be able to make overpayments - this will be taken from the capital you owe and lowers the debt you have to pay at the end
there could be tax advantages with interest-only mortgages for buy-to-let investors
The cons of an interest-only mortgage:
you'll still owe the full amount of what you borrowed by the end
you may need to use savings, investments, which could leave you short of cash for retirement or other projects
you might still not have enough to pay off all the debt if you put money into an investment plan over the life of the loan
you may not be able to repay your original mortgage loan at the end of the term
you could end up in negative equity if your property’s value decreases and your mortgage is more than your property is worth
you’ll pay more interest in total over the term of your mortgage compared to a repayment mortgage
How to repay your interest-only mortgage
You’ll need to have the full value of your loan ready to repay your lender at the end of your interest-only mortgage. This is referred to as your ‘repayment vehicle’.
You will have to demonstrate to your lender that you have access to one of the following options before you get accepted for an interest-only mortgage.
Your repayment vehicle could come from:
Savings that you’ve set aside for the end of your mortgage. You could do this by saving money in an ISA or another type of savings account
Selling other assets or property. If you have other properties you may choose to sell them to make up the amount you need to pay back your mortgage
Stocks and shares
It’s important to keep track of your planned repayment vehicle in case anything changes and you may need to consider a new arrangement.
What if I can’t pay off my interest-only mortgage?
If you come to the end of your mortgage and are concerned about whether you can afford to pay off the lump sum amount, there are options. You could:
extend your mortgage term, giving you more time to gather the money you need to pay off the value of your loan
remortgage with a different lender
release equity in another property you own if you are above the age of 55
Compare some of our best interest-only mortgage deals
Our guide about buy-to-let mortgages
Learn about fixed rate mortgages and how they work