Interest Only vs Repayment Mortgage
Below, we give an indication as to when an Interest Only vs Repayment Mortgage would be best.
But first, when considering whether to have your Mortgage on an interest only or a repayment. It’s important to consider the advantages and disadvantages of each.
In addition, it’s best to consider your end goal and whether your Mortgage has any flexibility which could affect your decision.
For example, do you plan to sell your property in the near term. And does your lender allow unlimited or limited overpayments.
Let’s have a look at your repayment options and go through the benefits and negatives of each.
But before we do. Please remember to always get professional advice before making a final decision.
What are the main Mortgage repayment options?
Capital & Interest Repayment Mortgage
Part Interest Only & Part Repayment
Capital and Interest Repayment Mortgage
More recently, repayment Mortgages are the main method of repayment choice for residential Mortgages.
With a Capital and Interest Repayment, you repay the Mortgage balance and Interest owed to the Lender.
This means at the end of your term, providing you have made all of your repayments, your Mortgage is guaranteed to be repaid at the end of the Mortgage.
This is a method of choice for most borrowers buying a home to live in.
This is because homeowners want to ensure that at the end of their Mortgage term, the property is theirs and owned outright.
An Interest Only Mortgage is where the borrower just pays the Interest to the Lender each month and doesn’t pay anything off the Mortgage balance.
As a result, at the end of your Mortgage term you will still have the full balance of the Mortgage to pay off.
This means if you haven’t made any provisions to repay the Mortgage, you will need to sell the property to repay the Mortgage to the Lender.
Interest Only Mortgages were once common among Residential and Buy to Let Mortgages.
They have become less common amongst Residential Mortgages mainly as Lenders have been forced to tighten their Lending Criteria around Interest Only.
Meaning you will often have to have a large deposit (at least 25%) and be a high income earner.
Making Interest Only Mortgages unavailable for most residential purchases.
Part & Part and Offset Mortgages
Part Interest Only & Part Repayment – As it sounds, your Mortgage is part capital and interest repayment and part interest only.
Meaning a portion of your Mortgage will be repaid at the end of your term and the interest only part of your Mortgage balance will still need to be repaid.
Offset Mortgage – A type of Interest Only mortgage good for those with a high level of savings and usually taken out when savings rates are low.
The borrower has a savings account linked to their Mortgage. The money saved in the account is taken away (or “offset”)from the Mortgage balance which you pay interest on.
Advantages and Disadvantages of Capital & Interest Repayment Mortgage
The main benefit of Repayment Mortgages are, providing you keep up with repayments your Mortgage is guaranteed to be repaid at the end of your term.
Provides certainty to you that you will be mortgage free after a set term.
You will pay less interest overall because as your Mortgage balance reduces so will the amount of interest that you pay.
You’re equity (difference between property value and Mortgage), will increase quicker over time and make you eligible for cheaper Mortgages. Again saving on the amount of interest you pay.
They only main negative is your monthly payment will be great than if your Mortgage was Interest Only. A real negative if you are looking to maximise profit from a rental or if you’re on a truly tight budget.
Advantages and Disadvantages of Interest Only
The main benefit of Interest Only Mortgages are to the cost of your monthly payment. Your monthly payment will be cheaper than if you were on a repayment Mortgage. This is good if you are looking to maximise your profit on a rental property. Or if you are on a truly tight budget.
You have the option to invest your money elsewhere, that you would have otherwise spent on your repayments. If you invest in something that makes you more money than what would have been paid off your Mortgage. Then you’re onto a winner.
If your property increases in value, then your initial investment and your equity in the property goes up.
More expensive overall as you pay interest on the whole Mortgage for the whole term.
If you have a poor performing repayment strategy or don’t have one at all. You’ll be forced to sell the property to repay your mortgage.
A greater risk of negative equity (where your Mortgage is worth more than your property), if your property falls in value. This would mean more expensive interest rates. And could mean you have to pay a shortfall to repay the Mortgage, if sale of property is your repayment strategy.
Repayment or Interest Only Mortgage
When are Repayment Mortgages best?
Where you have a low deposit and/or low income. Or, you want to be sure that at the end of the term of your Mortgage, it is repaid and your Home is yours and debt free.
Buy to Let Mortgages:
You would like to keep the property at the end of the term of your Mortgage. And, are unlikely to have an alternative repayment method to clear the Mortgage at the end of the term.
Or, you are not as concerned with the monthly income that rent would provide. And would rather your Buy to Let property be a long term investment which increases in value over the years.
When are Interest Only Mortgages best?
Where you have a high deposit and a repayment strategy (sale of other property or Stocks & Shares ISA) you are committed to and isn’t a high risk or speculative investment.
Buy to Let Mortgages:
If you are looking to maximise profit from the rent you receive and are happy to sell the property in the future.
We hope this has given you a good insight into whether an Interest Only vs Repayment Mortgage would be best for you.
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