There are two principal types of mortgage: interest-only and repayment. As the name suggests, if you have an interest-only mortgage your monthly payment only covers the interest charged on the mortgage debt. The mortgage balance itself does not reduce, but is paid off at intervals or at the end of the mortgage term, usually from a separate “repayment vehicle” such as an endowment policy or ISA. With a repayment mortgage – also sometimes referred to as a “capital and interest” mortgage – the monthly payments cover not only the interest, but are calculated to reduce the mortgage balance with each payment, ensuring the amount borrowed is totally repaid at the end of the agreed term.
Reasons for switching from interest-only to repayment
One of the main reasons for choosing to change from an interest-only mortgage to a repayment mortgage is if your endowment, ISA or other repayment vehicle is not performing as well as expected, meaning that it may not pay out sufficient funds on maturity to fully repay your mortgage. Endowment policies, which were popularly sold as repayment vehicles alongside mortgages in the 1980s and early 1990s, have for some been particularly problematic in this regard.
If you believe that there is going to be a shortfall in the amount required to repay your mortgage, then you may choose to switch it to a repayment basis, ensuring that the debt will be fully paid off by the end of the mortgage term. It may also be possible to address the projected shortfall by transferring just part of your mortgage to a repayment basis, with the amount you believe will be covered by the repayment vehicle staying on an interest-only basis; this is sometimes called a “part-and-part” mortgage (because it is part interest-only and part repayment).
Some people also choose to switch from interest-only to a repayment mortgage by choice, rather than necessity. Although the monthly payments for a repayment mortgage are higher, you will be reducing your mortgage balance – and therefore, the interest charged – with every payment you make. This may not make much difference in the short term, but added up over 5, 10 or 15 years it can mean paying thousands of pounds less in interest.
Switching mortgage type with your current lender
It’s usually fairly straightforward to switch your existing mortgage from interest-only to a repayment basis with your current lender, although the exact process can vary from one lender to another. You may be able to make the change on either an execution-only basis – where the lender doesn’t give you any advice, just acts on your instructions – or on an advised basis, which usually involves speaking to a mortgage adviser over the phone or in a branch. Either way you will typically still have to demonstrate affordability.
In some cases it’s possible to just switch the repayment type and stay on the same mortgage product – the deal that determines your interest rate. In other instances – for example if your mortgage product was only available on interest-only mortgages – you may have to switch to a different mortgage deal, which usually means a change in interest rate (which could potentially be either higher or lower than you’re currently paying). If you are within a tie-in period on your existing mortgage product, this may even involve having to pay an early repayment charge to come out of it before the agreed term.
Remortgaging to a different lender
If you are considering changing your mortgage type, it can often make sense to look at your mortgage options in a wider sense. Monthly payments on a repayment mortgage are higher than the payments on an equivalent interest-only mortgage – and the shorter the remaining mortgage term, the greater the difference will be.
Depending on your current mortgage product (and whether you have to pay an early repayment charge) it’s sometimes possible to maximise affordability by remortgaging entirely – closing your interest-only mortgage with your current lender and taking out a new repayment mortgage deal with a new provider. Be aware that if you want to opt for a part-and-part mortgage (keeping part of the balance on an interest-only basis) then your options may be more limited, as many lenders now have tighter criteria for acceptance or simply no longer take on new interest-only lending.