Interest Only Secured Loans: Options, Lenders and FCA Requirements

How interest only differs from capital and interest

In a capital and interest (C&I) loan, each monthly payment consists of two components: the interest for that month and a portion of the capital. Over the loan term, the balance gradually reduces to zero and the loan is fully amortised. By the end of the term, you own the property outright (assuming the first charge is also amortised).

In an interest only (IO) loan, each monthly payment consists only of the interest. The capital balance remains unchanged throughout the term. At the end of the term, the full original capital is still owed and must be repaid in a single lump sum from a pre-agreed repayment vehicle — savings, pension, investment, sale of the property, etc.

The monthly payment on IO is materially lower than C&I because the capital repayment element is removed. On a £50,000 20-year loan at 9% APRC:

Cashflow advantage of IO: £75 per month for 20 years. Capital shortfall at term end: £50,000. The economics of IO depend entirely on the repayment vehicle performing as planned.

FCA MCOB rules on interest only lending

The FCA’s MCOB rules on IO lending were tightened after the Mortgage Market Review in 2014 and apply in full to secured loans. Key requirements include:

• The lender must assess and be satisfied with the credibility of the repayment vehicle.
• The lender must periodically review the vehicle during the life of the loan.
• If the repayment vehicle is speculative (for example, hoped-for investment returns), the lender should not proceed with IO.
• The borrower must understand the capital will still be owed at term end.
• The lender must inform the borrower at intervals of the term-end capital balance still due.
• Under Consumer Duty, IO must deliver good outcomes — which means careful assessment of whether the borrower can realistically clear the capital.

These rules mean IO is not a default product option on most UK second charge secured loans. Where it is offered, the lender will require specific evidence of the repayment vehicle before approving. This can include: pension forecast statements, investment portfolio statements, confirmation of expected inheritance with IHT advice, property sale plans with LTV stress testing, or endowment policy documentation.

Acceptable repayment vehicles under FCA rules

The FCA has guidance on what constitutes an acceptable repayment vehicle. Widely accepted vehicles include:

• Sale of the property: most common; requires credible LTV stress testing showing sale proceeds will clear the loan even in a moderate market decline.
• Pension tax-free lump sum: up to 25% of pension value; requires forecast statements showing sufficient projected value.
• ISA or investment portfolio: current value must cover the capital; typically with some buffer for market variation.
• Endowment policy: rare today but still valid where one exists and is projected to pay out sufficiently.
• Expected inheritance: acceptable on case-by-case basis; documentation usually required.
• Sale of another asset: BTL property, business, second home.
• Refinance at term end: problematic; most lenders do not accept this because it does not genuinely clear the capital.

Less acceptable: future earnings, speculative business growth, lottery winnings (obviously). The underlying test is whether the vehicle is credible now and likely to remain so over the full term.

Which UK lenders offer interest only secured loans

IO second charge secured loans are available from a relatively narrow group of UK lenders:

• Shawbrook: IO available for BTL second charges and some owner-occupier cases with strong repayment vehicles.
• Paragon Bank: standard on BTL; more restricted on owner-occupier.
• InterBay Commercial: IO is the norm on BTL, HMO and semi-commercial second charges.
• Aldermore: IO on BTL; owner-occupier considered with solid repayment vehicle.
• Together Money: flexible on IO with various repayment vehicles.
• Pepper Money: part-interest-only options on some plans.
• Equifinance: IO considered on case-by-case basis for older borrowers using pension income.

For pure BTL second charges, IO is routine. For owner-occupier residential, it is specialised and requires careful structuring. A specialist broker will identify which lenders suit your specific repayment vehicle and circumstances. Rate premiums for IO versus C&I are typically minimal — 0 to 25 basis points at most — because the credit risk is similar.

Worked examples of IO secured loan cases

Three illustrative IO second charge scenarios:

In each case, the monthly payment is significantly lower than a C&I equivalent — improving cashflow. But at term end the full capital balance is still owed. The repayment vehicle must then be credibly available. For the BTL case, property sale is normally straightforward. For the pension exit case, the pension value at 60 must cover the £75,000 with buffer. For the ISA case, the current £75,000 portfolio provides 50% buffer over the £50,000 — comfortable for most underwriters.

The risks of interest only secured loans

IO borrowing carries specific risks that borrowers should understand:

• Capital shortfall at term end: if the repayment vehicle underperforms, you have a lump sum due and no clear way to pay it.
• Forced sale: in a worst case, the lender may require sale of the property to recover capital.
• Market risk on investment-based vehicles: ISA and pension values are not guaranteed; a market crash near term end could leave a shortfall.
• Longevity risk on pension exits: taking 25% tax-free lump sum reduces pension income in retirement.
• Property price risk on sale-based exits: declining market values may leave insufficient sale proceeds.
• Behavioural risk: lower monthly payments can mean borrowers fail to save for the capital, assuming something will come up.
• Review failures: if the repayment vehicle deteriorates mid-term, you may be moved to C&I at a much higher monthly cost.

The FCA and lenders have learned from the wave of IO mortgage failures in the 2010s. Modern IO secured loans are much more carefully assessed, but borrower discipline remains essential.

Part-interest-only and mixed structures

Some lenders offer part-interest-only structures — part of the loan is C&I, part is IO. This can be useful where the repayment vehicle is limited:

• £100,000 loan structured as £50,000 C&I plus £50,000 IO.
• Monthly payment lower than full C&I but higher than full IO.
• Capital at term end: only the £50,000 IO portion remains.
• Repayment vehicle needs to cover only the IO portion.

Part-and-part structures are more common on BTL than owner-occupier, and are useful where the borrower wants some cashflow benefit but does not have a large enough repayment vehicle to support full IO. Your broker will model the trade-offs — monthly payment impact, capital remaining at term end, total interest cost — so you can make an informed choice.

Is interest only right for you?

IO is right for specific scenarios and wrong for others:

IO typically suits: BTL investors with rental income stress and clear sale/refinance exit; older borrowers with substantial pension rights being drawn soon; investors with large, diversified investment portfolios; property investors using capital for further deposits.

IO typically does not suit: owner-occupiers with no other substantial assets; borrowers whose main plan is that something will turn up; cases where rate changes could move IO payments beyond affordability; older borrowers whose pension pot is modest.

Under Consumer Duty, the broker must evidence why IO is the appropriate structure. If the only reason is the lower monthly payment, that is usually not sufficient justification — a longer-term C&I loan achieves similar monthly payment outcome without leaving a capital shortfall at term end. A good broker will model both structures honestly and recommend the one that delivers the genuinely better outcome for your situation.