Interest Only vs Repayment Remortgage

How Repayment Remortgages Work

A repayment remortgage, also known as a capital and interest mortgage, is the most common type of residential mortgage in the UK. Each monthly payment covers both the interest charged on the loan and a portion of the capital balance. Over the full mortgage term, you gradually pay off the entire loan so that by the end of the term, the mortgage is fully repaid and you own the property outright.

In the early years of a repayment mortgage, the majority of each monthly payment goes towards interest, with only a small portion reducing the capital. As the balance decreases over time, the interest portion reduces and a larger share of each payment goes towards repaying the capital. This is why the equity you build accelerates in the later years of the mortgage.

For example, on a 200,000-pound repayment mortgage over 25 years at 4.5%, the monthly payment would be approximately 1,111 pounds. In the first month, about 750 pounds would be interest and 361 pounds would reduce the capital. By the final year, almost the entire payment would be going towards capital. Over the full 25 years, you would pay approximately 133,000 pounds in total interest but would own the property outright.

The key advantage of a repayment mortgage is certainty. Provided you make all your monthly payments on time, you are guaranteed to own your home free and clear at the end of the term. There is no need for a separate repayment strategy or investment plan, and no risk of reaching the end of the term still owing money.

Repayment mortgages are straightforward and widely available. Almost all residential mortgage products can be taken on a repayment basis, giving you the widest possible choice of lenders and rates when remortgaging.

How Interest-Only Remortgages Work

An interest-only remortgage requires you to pay only the interest charged on the loan each month. Your monthly payments do not reduce the capital balance at all, which means you still owe the full original loan amount at the end of the mortgage term.

Using the same example of 200,000 pounds at 4.5%, the monthly interest-only payment would be approximately 750 pounds, compared to 1,111 pounds on a repayment basis. This is a significant saving of 361 pounds per month, which is one of the primary attractions of interest-only mortgages.

However, at the end of the mortgage term, you would still owe the full 200,000 pounds. You must have a credible plan, known as a repayment vehicle, to pay off this lump sum when the mortgage matures. Common repayment vehicles include:

• Sale of the property - Selling the mortgaged property and using the proceeds to repay the loan, while moving to a cheaper property or renting
• Sale of another property - If you own other properties, selling one to repay the interest-only mortgage
• Investments and savings - Using ISAs, pensions, shares, or other investments that have grown sufficiently to cover the debt
• Downsizing - Selling the property, repaying the mortgage, and buying somewhere cheaper with the remaining equity
• Inheritance - Using an expected inheritance to repay the mortgage, though this is uncertain and generally not accepted by lenders as a primary repayment strategy

Interest-only residential mortgages have become much harder to obtain since the Mortgage Market Review in 2014, which tightened lending standards. Most lenders now require a clear and evidenced repayment strategy, significant equity in the property (usually at least 25% to 50%), and sometimes a minimum income level.

It is important to understand that over the full term of an interest-only mortgage, you pay more total interest than on a repayment mortgage for the same initial loan amount. This is because the balance never decreases, so interest is charged on the full amount throughout.

Monthly Cost and Total Interest Comparison

The difference in monthly payments between interest-only and repayment mortgages is significant, but the total cost over the life of the mortgage tells a very different story.

Example: 250,000-pound mortgage at 4.5% over 25 years

Repayment mortgage:

• Monthly payment: approximately 1,389 pounds
• Total interest over 25 years: approximately 167,000 pounds
• Total amount paid: approximately 417,000 pounds
• Amount owed at end of term: zero

Interest-only mortgage:

• Monthly payment: approximately 938 pounds
• Total interest over 25 years: approximately 281,000 pounds
• Total amount paid in interest: approximately 281,000 pounds
• Amount still owed at end of term: 250,000 pounds

The monthly saving on interest-only is approximately 451 pounds, which over 25 years totals around 135,000 pounds. However, the total interest paid on the interest-only mortgage is approximately 114,000 pounds more than on the repayment mortgage. And critically, you still owe the original 250,000 pounds at the end.

For interest-only to be financially beneficial, the 451 pounds per month that you save on payments needs to be invested effectively enough to both cover the 250,000-pound repayment and compensate for the additional interest paid. This is a significant challenge, and historically many borrowers with interest-only mortgages have found their repayment vehicles falling short.

The interest-only approach can work well for disciplined investors who consistently invest the monthly savings into a well-performing portfolio. It can also work for buy-to-let landlords where the property itself is the repayment vehicle and rental income covers the interest payments. For most residential borrowers, however, a repayment mortgage is the safer and more straightforward option.

Eligibility and Lender Requirements

The eligibility criteria for interest-only and repayment remortgages differ significantly, reflecting the different risk profiles of each product type.

Repayment remortgage eligibility:

• Income - You need sufficient income to meet the lender's affordability assessment, typically assessed at a stressed rate higher than the actual mortgage rate
• LTV - Available up to 95% LTV with some lenders, though rates improve significantly at 80% and below
• Credit history - Clean credit history preferred, though specialist lenders cater to borrowers with adverse credit
• Age - Most lenders have a maximum age at the end of the term, typically 70 to 80 years old
• Repayment strategy - None required, as the mortgage is self-repaying through monthly payments

Interest-only remortgage eligibility:

• Income - Higher income thresholds often apply, with some lenders requiring a minimum income of 75,000 pounds or more
• LTV - Typically limited to 50% to 75% LTV, with very few lenders offering interest-only above 75%
• Repayment strategy - You must demonstrate a credible and evidenced plan to repay the capital at the end of the term
• Net worth - Some lenders require minimum net worth or asset levels
• Credit history - Generally stricter requirements than for repayment mortgages
• Property value - Some lenders only offer interest-only on higher-value properties

Since the Mortgage Market Review reforms, the FCA expects lenders to thoroughly assess whether an interest-only borrower has a realistic plan to repay the capital. Lenders must not rely solely on future property price growth as a repayment strategy. This has made interest-only mortgages harder to obtain for residential purposes, though they remain widely available for buy-to-let properties.

If you currently have an interest-only mortgage and want to remortgage, your options may be limited if you do not have a credible repayment strategy. Some lenders will allow like-for-like interest-only remortgages, while others may require you to switch to a repayment or part-and-part basis.

Part-and-Part Mortgages: A Middle Ground

If you want the lower monthly payments of interest-only but the security of gradually repaying your mortgage, a part-and-part mortgage offers a compromise. This involves splitting your mortgage so that a portion is on a repayment basis and the remainder is interest-only.

For example, on a 250,000-pound mortgage, you might put 150,000 pounds on repayment and 100,000 pounds on interest-only. Your monthly payments would be lower than a full repayment mortgage but higher than full interest-only. Over the term, you would repay the 150,000-pound repayment portion, leaving only 100,000 pounds to deal with at the end.

Part-and-part mortgages can work well for borrowers who:

• Cannot quite afford the full repayment amount but want to make some progress on reducing the capital
• Have some assets for the interest-only portion but not enough to cover the entire mortgage
• Want to balance cash flow flexibility with long-term debt reduction
• Are transitioning from a fully interest-only mortgage towards repayment and want to do so gradually

The proportion split between repayment and interest-only can be adjusted to suit your affordability and goals. Some lenders allow you to change the split during the mortgage term, giving you flexibility to increase the repayment proportion as your income grows.

Lender criteria for part-and-part mortgages typically require a repayment strategy for the interest-only portion, similar to a fully interest-only mortgage. However, the smaller interest-only element means the repayment strategy needs to cover a lower amount, which can make it easier to satisfy lender requirements.

Not all lenders offer part-and-part arrangements, so using a broker is advisable to identify which lenders will accommodate this structure and on what terms.

Which Option Should You Choose for Your Remortgage?

The right choice between interest-only and repayment depends on your financial situation, your goals and your discipline as a saver or investor.

A repayment remortgage is generally the better choice if:

• You want the certainty of knowing your home will be fully paid off at the end of the term
• You do not have a robust investment strategy or alternative way to repay the capital
• You are a residential homeowner who wants to build equity steadily over time
• You want the simplest, most straightforward approach to your mortgage
• You are risk-averse and prefer the security of guaranteed capital repayment

An interest-only remortgage may be appropriate if:

• You are a buy-to-let landlord where the property itself is the repayment vehicle
• You have a proven investment strategy that historically generates returns exceeding the mortgage interest rate
• You need lower monthly payments for cash flow purposes and have sufficient assets to cover the capital repayment
• You are a high earner with significant savings and investments who wants to optimise their financial strategy
• You have a clear and credible plan to repay the capital at the end of the term

If you are currently on an interest-only mortgage and your repayment strategy is not on track, remortgaging to a repayment basis may be the most prudent course of action, even though it means higher monthly payments. The earlier you switch, the more manageable the payments will be, as you will have more years to spread the capital repayment across.

If you are approaching the end of an interest-only mortgage term and do not have the funds to repay the capital, contact your lender or a mortgage adviser immediately. Options may include extending the term, switching to repayment, downsizing, or in some cases, taking a retirement interest-only mortgage. The worst thing you can do is ignore the problem and hope it resolves itself.

Whatever you decide, ensure your choice aligns with your long-term financial plan. A mortgage adviser regulated by the FCA can help you model different scenarios and understand the true cost and risk of each option over the full mortgage term.