The vast majority of homebuyers in the United Kingdom purchase properties using one of two primary mortgage types:
- Interest-only mortgages
- Repayment mortgages
Both options have their own unique advantages and disadvantages, but which of the two is more suitable for your preferences and your financial situation?
Repayment mortgages: an overview
A repayment mortgage is when the monthly repayments you make gradually clear both the balance of the mortgage and the interest payable.
When the mortgage is arranged, the total interest cost is added to the initial mortgage value, the combined sum of which is then divided by the number of months over which the mortgage will be repaid.
At the end of the agreed repayment period, usually 15 to 30 years, your mortgage is paid off in full, and you own your home outright.
Interest-only mortgages: an overview
An increasingly popular option for many homebuyers, interest-only mortgages differ in that your monthly repayments only contribute to the interest you owe on the mortgage.
You gradually pay off the interest on your mortgage on a monthly basis, but not the actual mortgage balance itself. This means that at the end of the repayment term, you still owe the lender the full mortgage amount, minus the interest you have repaid.
Subsequently, the borrower needs to repay the mortgage balance to take ownership of their home, which is usually accomplished by one of the following methods:
- Paying off the remaining balance using a different type of mortgage or loan, repaid gradually on a monthly basis
- Using a lump sum to pay off the mortgage balance outright, perhaps with a pension withdrawal or inheritance
After repaying the interest on an online mortgage, it is also possible to sell your home and repay the lender using the funds raised.
Which is the more cost-effective option?
Cost-effectiveness varies when considering the two options from a short- or long-term perspective. If you were to take out a £160,000 mortgage at an interest rate of 4%, this is how much you would subsequently repay:
- Repayment mortgage: £92,316 Interest: Total Cost: £252,316
- Interest-only mortgage: £166,175 Interest: Total Cost: £326,175
This in turn means that over the course of the loan in its entirety, a repayment mortgage will almost always work out more cost-effectively. However, interest-only mortgages offer the benefit of significantly lower initial monthly repayments.
Using the example listed above, monthly repayments on the same £160,000 mortgage would be as follows:
- Interest-only mortgage: £533.92 per month
- Repayment mortgage: £841.05 per month
In both instances, various additional borrowing costs, such as arrangement fees, valuation fees, legal fees, and completion fees, also need to be factored in.
Before choosing whether to apply for an interest-only remortgage or a traditional repayment mortgage, it is important to discuss all options available with an independent broker and compare the market in full.
Repayment mortgages: key advantages
The biggest points of appeal with a competitive repayment mortgage are as follows:
- Significantly lower overall interest payable on the loan, as your total outstanding mortgage balance is reduced with every payment. This can result in major long-term savings over the life of the loan.
- More competitive rates of interest are usually available on repayment mortgages, though this varies from one lender to the next and is dependent on conducting a full market comparison.
- You take ownership of your property upon completing repayment of your mortgage, with no additional monthly repayments or lump sum payments to be made.
As outlined above, the primary disadvantage of a repayment mortgage is (often) significantly higher monthly repayments. It is therefore essential to ensure you can comfortably afford the agreed-upon repayments for the duration of the loan term.
In addition, very little is repaid on the balance of a traditional repayment mortgage over the first few years, and it is not always possible to overpay without facing steep penalties or additional fees.
Interest-only mortgages: key advantages
A competitive interest-only mortgage can also be beneficial in many ways, including but not limited to the following:
- Much lower monthly repayments as you are simply repaying the interest payable on the loan, not the outstanding mortgage balance.
- The opportunity to turn a profit if you sell your home for a high price after repaying the interest, in order to repay the lender and retain any profits generated,
- Greater flexibility and financial security due to fewer monthly outgoings, enabling you to allocate more of your income to other expenses.
The flexibility of an interest-only mortgage can be appealing, but interest-only loans are almost always significantly more expensive long-term. They can also be much more complex to manage, as you also need to decide on a means by which to repay the mortgage balance in full.
Should I choose a repayment mortgage or interest-only?
Interest-only mortgages are only suitable for certain borrowers in very specific situations. If you cannot guarantee that you will have access to the funds needed to repay your mortgage after the initial interest repayment period, it is inadvisable to apply for an interest-only mortgage.
This is something that should be discussed in detail with an independent broker prior to your application going forward. After which, a detailed market comparison can be performed to ensure you get the best possible deal from a reputable lender.
What is a part-and-part mortgage?
A part-and-part mortgage is a specialist type of home loan wherein the monthly repayments you make contribute to both the interest payable and the mortgage balance. It is therefore similar in nature to a traditional mortgage, though you will still be left with an outstanding sum to pay at the end of the term to take ownership of your home.
The suitability of part-and-part mortgages and the cost-effectiveness of such loans vary significantly from one agreement and applicant to the next. Your broker will help you build an understanding of the potential pros and cons of this specialist type of home loan. Before applying, you could even use our UK mortgage calculator to find our costs more accurately.
Is it possible to switch from interest-only to repayment?
Many interest-only mortgage payers make the decision to switch to a repayment mortgage towards the end of the loan term in order to allow them to repay the outstanding balance on their home on a monthly basis. However, doing so will result in a significant monthly repayment increase, as repayment mortgages attach higher monthly repayments than interest only.
It is also possible to switch the other way in order to reduce monthly repayments by repaying only the interest on your mortgage. However in doing so, the total amount you will repay long-term will increase significantly.
If you would like to discuss any of the above in more detail, we would be happy to provide you with an obligation-free consultation at your convenience. Call UK Property Finance anytime or email us with your request, and we will get back to you as soon as possible.