The differences between an interest-only & repayment mortgage?

What are the differences in repayments between an interest-only and repayment mortgage?

Whether you are taking out a new mortgage, or considering changing your mortgage repayment type, it’s important to understand the differences between interest-only mortgages and repayment (capital and interest) mortgages, in terms of both how they work, and how much you’ll have to pay each month.

Interest Only Vs Repayment Mortgage

Interest Only

Interest-only mortgages have the advantage of lower monthly payments, but that’s because your payment only covers the interest being charged on the amount borrowed. The actual mortgage balance, or capital, doesn’t reduce over the mortgage term, but is repaid in full at the end or by lump sum reductions throughout, usually by means of a repayment vehicle such as an endowment policy, ISA or other investment plan.

Repayment Mortgage

A repayment mortgage has a higher monthly payment than an equivalent interest-only mortgage, and that’s because each month a portion of the debt is being paid off, so by the end of the agreed mortgage term the balance has been reduced to zero. Because the mortgage capital is always reducing, this also means that you will typically pay less total interest over the overall mortgage term in comparison to an interest-only mortgage – the examples below illustrate this.

Mortgage interest rates vary with market conditions – at any given time there might be hundreds of different mortgage products on the market – and can also depend on factors such as the amount of deposit you’re able to put down, and your credit score. However, here we’ll take a look at a range of typical interest rates – 3%, 4% and 5% – and break down how an interest-only mortgage and a repayment mortgage would compare.

Example Scenario

A purchase price of £236,000 – the average house price in England in mid-2016 – with a 25% deposit put down, therefore requiring a mortgage of £177,000, which is being taken out over a 25-year term.

The figures quoted assume a constant interest rate over the mortgage term, and that the mortgage balance isn’t otherwise increased (for example, by additional borrowing or fees being added) or decreased (as a result of lump sum part repayments or regular overpayments). The monthly payments quoted do not include any other factors, such as home insurance or redundancy insurance, and for ease of illustration all figures are rounded to whole pounds.

3% interest rate

Interest-only mortgage:

At an interest rate of 3%, your interest-only mortgage payment would be £442.

The total amount repayable over the term would be £309,681, which consists of the £177,000 borrowed, which must be repaid at the end of the mortgage term, and total interest of £132,681, paid in equal monthly instalments over 25 years.

Repayment mortgage:

At an interest rate of 3%, your repayment mortgage payment would be £839.

The total amount repayable over the term would be £251,764, which consists of the £177,000 borrowed, which is repaid via your monthly payments over 25 years total interest of £74,764, paid as part of your monthly payments over 25 years.

4% interest rate

Interest-only mortgage:

At an interest rate of 4%, your interest-only mortgage payment would be £589.

The total amount repayable over the term would be £353,823, which consists of the £177,000 borrowed, which must be repaid at the end of the mortgage term, and total interest of £176,823, paid in equal monthly instalments over 25 years.

Repayment mortgage:

At an interest rate of 4%, your repayment mortgage payment would be £934.

The total amount repayable over the term would be £280,164, which consists of the £177,000 borrowed, which is repaid via your monthly payments over 25 years total interest of £103,164, paid as part of your monthly payments over 25 years.

5% interest rate

Interest-only mortgage:

At an interest rate of 5%, your interest-only mortgage payment would be £738.

The total amount repayable over the term would be £398,412, which consists of the £177,000 borrowed, which must be repaid at the end of the mortgage term, and total interest of £221,412, paid in equal monthly instalments over 25 years.

Repayment mortgage:

At an interest rate of 5%, your repayment mortgage payment would be £1,035.

The total amount repayable over the term would be £310,530, which consists of the £177,000 borrowed, which is repaid via your monthly payments over 25 years total interest of £133,530, paid as part of your monthly payments over 25 years.

Whilst the above clearly demonstrates that interest only can result in a much more expensive overall cost, it does not mean that a repayment mortgage is always best suited to all.  It is therefore important that any potential borrower seeks all the relevant information before making a decision of which may be best for their own particular circumstances.