Mortgage Repayment Methods

Mortgage repayment methods

A repayment mortgage is also known as a Capital and interest mortgage. They involve the borrowing of a sum of money over a chosen period, traditionally over 25 years. The borrower or borrowers make a monthly payment to the lender, made up of interest and capital.

As the capital is gradually repaid each month, the outstanding debt is reduced. As a result, the interest content gradually reduces and the capital content increases as a proportion of the monthly payment. During the early years of a repayment mortgage, most of the monthly payments are interest and it is only in later years that the capital repayment overtakes the interest. After 25 years, the loan is fully repaid. The monthly payments on a repayment mortgage increases if interest rates rise and decreases if they fall. This is due to the interest charged on the mortgage and not the capital repayment.

As a repayment mortgage is the only guaranteed method of repayment at the end of the mortgage term, this is the preferred mortgage repayment method by mortgage lenders.

Interest only mortgage

With an interest only mortgage, the borrower only pays the mortgage interest payments to the mortgage provider each month and they are required to have a repayment method in place at the end of the mortgage term.

An interest only mortgage is very tempting to some due to the lower monthly payments because the capital repayment element is not included. The most popular method of repayment with an interest only mortgage used to be an endowment and in more recent years, a unit trust savings plan such as an Individual Savings Account (ISA). The borrower would start the interest only mortgage over a set term and the endowment or ISA would be set to mature or finish over the same period. There are, however no guarantees with this type of savings vehicle.

Mortgage lenders are now reluctant to approve residential interest only mortgages unless there is at least 25% or even 50% equity or deposit. This includes part interest only and part repayment mortgages. Lenders also have strict guidelines around any ISA's, investments or endowments being used as the repayment method. An interest only Buy to Let mortgage is treated differently to a residential mortgage because Buy to Let is treated as an investment. As such, it is expected that the property would be sold to repay the interest only mortgage.

Sale of property - Interest only mortgage

Some mortgage lenders will allow you to have an interest only mortgage if you own another property or properties in addition to the one being mortgaged. However, for this to be accepted there would need to be sufficient equity to repay the new interest only mortgage. Downsizing also needs to be realistic and isn't always an acceptable repayment method. This would depend on the mortgage lender. The same would apply for a future inheritance. Once again, this can not be guaranteed however so most lenders will no longer accept this.

We would recommend you discuss your options with someone from Impartial if you are considering an interest only mortgage.