Mortgages - How to repay your mortgage

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There are two ways to repay the amount you have borrowed (the "capital"). Their advantages and disadvantages are described below.

Key to Diagrams
  The part of the house you own (ie deposit and any capital repaid)
  The mortgage loan (ie the part of the house "owned" by the lender)
  Lump sum built up so far

Repayment Mortgage

Also called a capital and interest loan. your monthly payments gradually pay off the amount you owe as well as paying the interest charged on the loan. Provided you make all the agreed payments, the loan will be fully paid off by the end of the mortgage term.

Interest-only Mortgage

Your monthly payments cover only the interest on the loan. They do not pay off any of the capital. You will need to arrange to pay separately into a savings or investment scheme to build up a lump sum to pay off the mortgage at the end of the term.

Usually, you also make a separate payment each month into a savings scheme to build up a lump sum to repay the loan at the end of the mortgage term. It is your responsibility to make sure you have enough money to repay the mortgage at the end of the term, otherwise you could lose your home.

It is possible to have a mortgage where a proportion of it is treated as an interest only mortgage and a proportion like a repayment one. This is most common for people who already have an investment product arranged before taking out a mortgage, which they want to use to help reduce the additional cost of taking out the mortgage. For example, if you want to take out a £350,000 mortgage and already have an endowment that may pay out £100,000 in a number of years time, you could consider an interest-only element to cover the first £100,000 and a repayment element for the remainder.

Advantages and disadvantages of the repayment methods

Will it pay off the mortgage?

Repayment Mortgage - Yes, as long as you make all the payments agreed with the lender, the whole loan will be repaid by the end of the mortgage term,
Interest-only mortgage - No, not on its own. You need to have some other arrangement for repaying the loan. It is your responsibility to repay the mortgage at the end of the term, otherwise you could lose your home.

What if interest rates go up?

It doesn't matter which method you have, if interest rates rise, your payments will normally increase (unless you have a fixed interest rate).

Moving home and re mortgaging

Repayment Mortgage - You will usually have paid off some of the "capital" and so will need to pay back less than you borrowed.
Interest-only mortgage - Because you won't have repaid any "capital" you will need to pay off the same amount that you borrowed.

What if you run into problems keeping up your monthly repayments?

Repayment Mortgage - You could ask your lender to extend the term or accept interest-only payments for a while. This reduces the amount you pay each month in the short term but increases the total cost of the loan. Your lender might agree to stop your payments for a while.
Interest-only mortgage - Your lender might agree to reduce or even stop the mortgage payments for a while. You will not necessarily be able to reduce the amount you pay each month into a savings scheme (particularly if it is an endowment policy).

Is this a suitable mortgage for you?

Repayment Mortgage - Yes, if you want to be absolutely sure that your loan will be fully repaid at the end of the term. Don't forget your monthly payments could increase if interest rates rise.
Interest-only mortgage  - Whether an interest-only mortgage suits you depends on whether you're comfortable with taking the risk of repaying your mortgage with a savings plan or another method. It is your responsibility to repay the mortgage at the end of the term, otherwise you could lose your home.

Interest Only Warnings

Important information regarding interest only mortgages

With an interest only mortgage, your monthly payments only cover the interest charged and therefore the mortgage debt will not reduce. 

When the term of your mortgage finishes you will be expected to repay the loan in full or sell the property to redeem the loan.

By taking an interest only mortgage you increase the risk of negative equity compared with a repayment mortgage.

A repayment mortgage is a fair and true cost of your borrowing and by taking an interest only mortgage you need to consider whether you are basing your monthly expenditure on a falsely low monthly payment.

You mortgage will end up costing you more in the long run.  If you have borrowed a high percentage of value of your home, you are relying on house price inflation to clear the current loan, pay for your moving costs, and leave enough to equity to buy another property.  You may find that your next home is unaffordable, particularly if you are hoping to move up the housing ladder.

The asset may not be readily saleable, or may fall in value.  If it is a property, you need to be confident that there will be sufficient equity available to cover costs of selling (including clearing any mortgage on it), as well as the sum needed to repay the uncovered debt.

The longer you wait to switch to a repayment loan (particularly if you want to keep the term the same) the larger the jump in your monthly repayment is likely to be.  If the reason you want interest-only to start with is so you can affordthe mortgage, affordability may well continue to be a problem.  Your salary, and general financial position, might not improve as quickly as you are hoping it will.

It may not be safe to assume that downsizing (after moving costs) will repay the whole loan.  When it comes to the crunch, you may not want to downsize to clear the debt.  Downsizing to release funds to boost your income/lifestyle in retirement is one thing, but being forced to do so just to clear our debts is quite another.

Please contact our team of friendly professionals on 01903 527000 or please use our contact form for further advice.