Remortgage From Interest Only to Repayment

Why Switch From Interest Only to Repayment?

Interest only mortgages were extremely popular in the UK during the 1990s and early 2000s. Many homeowners took them out alongside endowment policies or other investment vehicles that were intended to grow enough to repay the mortgage at the end of the term. However, many of these investments underperformed, leaving borrowers with a significant shortfall.

Today, the regulatory landscape has changed significantly. The Financial Conduct Authority requires lenders to ensure borrowers have a credible repayment strategy for any interest only mortgage. For many homeowners, switching to a repayment basis is the most straightforward way to address this requirement and ensure their home is fully paid off.

Here are the main reasons to consider switching:

• Guaranteed debt clearance — With a repayment mortgage, each monthly payment reduces both the interest and a portion of the capital. By the end of the mortgage term, the entire debt is paid off and you own your home outright. This certainty is the single biggest advantage of switching.
• No reliance on investments — Interest only mortgages require a separate repayment vehicle, such as an endowment, ISA, or other investment, to accumulate enough to clear the balance. Investment performance is never guaranteed, and many homeowners have found themselves with insufficient funds. A repayment mortgage removes this risk entirely.
• Lender requirements — When you come to remortgage, most lenders now require a credible repayment strategy for any interest only borrowing. If you do not have one, switching to repayment may be your most viable option for accessing competitive deals.
• Approaching the end of your term — If your mortgage term is due to end in the coming years and you do not have sufficient funds to repay the capital, switching to a repayment basis and potentially extending the term can spread the cost and make it manageable.
• Peace of mind — Knowing that your mortgage balance is reducing month by month and that your home will be fully paid off by a set date provides considerable peace of mind, particularly as you approach retirement.

The main consideration when switching is that your monthly payments will increase, as you will be paying both interest and capital rather than interest alone. However, with careful planning and the right deal, this increase can be made manageable.

How Much Will Your Payments Increase?

One of the biggest concerns for homeowners considering the switch from interest only to repayment is how much their monthly payments will go up. The increase depends on several factors, including your outstanding balance, the interest rate, and the remaining term of your mortgage.

Understanding the difference

On an interest only mortgage, you pay only the interest on the amount borrowed. On a repayment mortgage, you pay the interest plus a portion of the capital, so the total amount owed reduces over time. Naturally, the monthly payment is higher on a repayment basis because you are paying off the actual debt as well as the interest.

Example: 200,000-pound mortgage at 4.5% interest

On an interest only basis, your monthly payment would be approximately 750 pounds. On a repayment basis over 20 years, the same mortgage would cost approximately 1,265 pounds per month. That is an increase of around 515 pounds per month. Over 25 years, the repayment figure would be approximately 1,112 pounds, an increase of around 362 pounds.

Factors that affect the payment increase:

• Remaining mortgage term — The longer the remaining term, the lower the monthly repayment figure, as the capital is spread over more months. If affordability is tight, extending the term can help reduce the payment increase.
• Interest rate — Securing a competitive interest rate when you switch will help minimise the overall cost. If you are currently on a high SVR, you may find that switching to a lower fixed rate partly offsets the increase from moving to repayment.
• Outstanding balance — The larger the remaining debt, the higher the repayment element. If you have the ability to make a lump sum payment to reduce the balance before switching, this will lower your monthly payments on the repayment basis.

While the payment increase is real and significant, it is important to weigh this against the alternative. If you remain on interest only without a credible repayment strategy, you will face the full balance as a lump sum when the mortgage term ends. Switching to repayment now spreads this cost over the remaining years and ensures the debt is dealt with systematically.

Can You Switch Part of Your Mortgage to Repayment?

If the full payment increase from switching entirely to repayment is not affordable, a part-and-part arrangement could be a practical solution. This involves splitting your mortgage so that a portion is on a repayment basis and the remainder stays on interest only.

How part-and-part mortgages work

With a part-and-part mortgage, you agree with your lender to convert a specified portion of your balance to repayment while keeping the rest on interest only. For example, on a 200,000-pound mortgage, you might switch 120,000 pounds to repayment and keep 80,000 pounds on interest only. This reduces the payment increase while still making meaningful progress on reducing your debt.

Advantages of a part-and-part arrangement:

• More affordable monthly payments — The monthly cost sits between a fully interest only and a fully repayment mortgage, making it more manageable.
• Gradual debt reduction — You start paying down part of the capital immediately, which reduces the balance you will owe at the end of the term.
• Flexibility — As your financial position improves, you may be able to increase the repayment portion or switch fully to repayment at a later date.
• Lender acceptance — Some lenders who might not approve a full switch to repayment on affordability grounds may accept a part-and-part arrangement.

Considerations:

You will still need a credible repayment strategy for the portion that remains on interest only. Lenders will want to know how you plan to repay this part of the balance when the term ends. Acceptable strategies might include the sale of the property, savings, investments, pension lump sums, or other assets.

A part-and-part arrangement is often an excellent stepping stone. It allows you to start addressing the capital repayment while keeping monthly costs within a manageable range. Over time, you can review your circumstances and potentially convert more of the balance to repayment as your income allows.

Affordability and Lender Criteria for the Switch

When you apply to remortgage from interest only to repayment, lenders will carry out a thorough affordability assessment. Because your monthly payments will increase, the lender needs to be satisfied that you can comfortably afford the higher amount.

What lenders assess:

• Income — Your gross and net income from all sources, including employment, self-employment, rental income, pensions, and any other regular income.
• Expenditure — Your essential monthly outgoings, including bills, living costs, childcare, other loan or credit card payments, and any other regular commitments.
• Stress testing — Lenders are required to check that you could still afford the payments if interest rates were to rise. They will apply a stress rate, typically 1% to 3% above the deal rate, to ensure you have a buffer.
• Credit history — Your credit file will be checked for any adverse markers such as missed payments, defaults, or county court judgements. A clean credit history improves your chances of approval.
• Remaining term and age — Lenders consider the remaining mortgage term and your age at the end of that term. If you are approaching retirement, the lender will want to see evidence that your retirement income is sufficient to cover the repayment mortgage payments, or they may suggest a shorter term.

Options if affordability is tight:

If a straight switch to full repayment is not affordable, there are several strategies that can help:

• Extend the mortgage term — Increasing the term reduces each monthly payment because the capital is spread over a longer period. However, this means you will pay more interest in total over the life of the mortgage, and the lender will need to be comfortable that you can maintain payments for the extended period.
• Switch to part-and-part — As discussed above, converting only a portion to repayment keeps the payment increase manageable.
• Reduce the balance first — If you have savings or can make a lump sum payment, reducing the outstanding balance before switching will lower the monthly repayment figure.
• Shop around — Different lenders have different affordability models. A whole-of-market broker can identify lenders whose criteria are most favourable for your specific circumstances.

A qualified mortgage adviser can help you navigate these options and present your application in the best possible light. They understand how different lenders assess affordability and can match you with the most suitable option.

The Process of Switching From Interest Only to Repayment

Switching from interest only to repayment can be done in two main ways: through a product transfer with your existing lender, or by remortgaging to a new lender. The right approach depends on the deals available and your individual circumstances.

Option 1: Product transfer with your existing lender

Many lenders allow existing customers to switch from interest only to repayment without going through a full remortgage. This process is typically simpler and quicker because the lender already holds your mortgage and may not require a new property valuation or full underwriting process. However, the deals available through a product transfer may not be as competitive as what you could find on the open market.

Option 2: Remortgage to a new lender

If you want to access the widest range of deals and potentially secure a lower interest rate, remortgaging to a new lender on a repayment basis is the way to go. The process involves a full application, property valuation, affordability assessment, and legal transfer. It takes longer than a product transfer, typically four to eight weeks, but it opens up the entire market.

Steps in the process:

1. Review your current mortgage terms, including any early repayment charges and exit fees.
2. Assess your current property value and calculate your loan-to-value ratio.
3. Calculate what your monthly payments would be on a repayment basis at current market rates.
4. Gather your financial documents, including proof of income, bank statements, and details of outgoings.
5. Consult a mortgage broker to compare deals from across the market.
6. Apply for a decision in principle with your chosen lender.
7. Submit a full application and provide all required documentation.
8. The lender carries out a valuation and affordability assessment.
9. If approved, the lender issues a formal mortgage offer on a repayment basis.
10. A solicitor handles the legal transfer if you are switching lenders.
11. Your new repayment mortgage begins, and each month you pay down both interest and capital.

Whether you go the product transfer or full remortgage route, the most important thing is to take action. The longer you remain on interest only without a clear plan to repay the capital, the more difficult the situation becomes as the end of your mortgage term approaches.

Planning Ahead: Interest Only Mortgages and Retirement

For many homeowners on interest only mortgages, the end of the mortgage term coincides with or falls close to their planned retirement date. This can create a significant financial challenge, as you may be facing a large capital balance to repay at a time when your income is reducing.

The scale of the issue

The FCA has highlighted interest only mortgages maturing without adequate repayment strategies as a significant consumer concern. If your mortgage term ends and you cannot repay the capital, your lender may take enforcement action, which could ultimately include repossession. While lenders are encouraged to work with borrowers to find solutions, this underlines the importance of planning ahead.

Switching to repayment before retirement

If you are still working and have several years until retirement, switching to a repayment mortgage now gives you time to clear the debt before your income drops. Even if you need to extend the term to make the payments affordable, having a clear path to owning your home outright before or shortly after retirement is valuable.

Options if you are already retired or close to retirement:

• Retirement interest only mortgage (RIO) — These relatively new products allow you to continue paying interest only for life, with the capital repaid when the property is sold, usually when you move into long-term care or pass away. The FCA treats these as standard regulated mortgages, and they can provide a viable solution for older borrowers.
• Downsizing — Selling your current home and buying a smaller, less expensive property can release enough equity to clear the mortgage balance and potentially leave you mortgage-free.
• Equity release — For homeowners aged 55 and over, equity release products allow you to access the value tied up in your home. However, these products compound interest over time and reduce the inheritance you can leave, so they should be considered carefully and with independent financial advice.
• Using savings or investments — If you have built up sufficient savings, investments, or pension lump sums, these can be used to repay all or part of the mortgage balance.

Whatever your situation, the key message is to take action as early as possible. The more time you have to address the issue, the more options are available to you. A mortgage adviser who specialises in later-life lending can help you explore all the possibilities and find the solution that best fits your circumstances.