Interest-Only vs Repayment Mortgage

What Each Type Actually Means

With a repayment mortgage - also called a capital-and-interest mortgage - your monthly payment is split into two parts. One part pays the interest charged that month, and the other part chips away at the loan balance itself. Provided you keep up the payments for the full term, you will own the property outright at the end, with nothing left to repay.

With an interest-only mortgage, your monthly payment covers only the interest. The underlying loan - the £250,000 you borrowed - does not shrink at all. At the end of the term, you still owe the full amount and must repay it from some other source, known as your repayment plan or repayment vehicle.

This distinction is the single most important thing to understand, because everything else - the lower monthly payments, the stricter lending rules, the end-of-term risk - flows directly from it.

Monthly Payments: £1,390 vs £938

The attraction of interest-only is obvious in the monthly payment. Take an illustrative £250,000 mortgage over 25 years at an interest rate of about 4.5%. On a repayment basis, the monthly payment comes out at roughly £1,390. On an interest-only basis, it is roughly £938 - the loan amount multiplied by the monthly interest rate.

That is a difference of around £450 a month, or about £5,400 a year. For a borrower whose income is tight today but is expected to grow, or who has a lump sum coming further down the line, that breathing room can look very appealing.

But the cheaper payment is not a saving - it is a deferral. With the repayment mortgage, a growing share of each £1,390 payment is reducing the debt. With the interest-only mortgage, every £938 disappears into interest and the £250,000 balance sits untouched for 25 years.

Total Interest Over 25 Years

Over a full 25-year term, the interest-only borrower pays interest on the full £250,000 for every one of those 300 months. At roughly 4.5%, that adds up to around £281,000 in total interest - more than the original loan itself - and the borrower still has to find £250,000 to clear the capital at the end.

The repayment borrower, by contrast, pays roughly £167,000 in total interest over the same 25 years (illustrative), and owns the property outright at the end. The shrinking balance means less interest is charged each year, which is why the total is so much lower despite the higher monthly payment.

In other words, the interest-only route costs roughly £114,000 more in interest on this example, plus the responsibility of repaying £250,000 in capital. That is the true price of the lower monthly payment, and lenders know it - which is why they set much tougher rules on who can take one out.

Who Can Get an Interest-Only Mortgage Since 2008

Interest-only lending was largely unregulated before the 2008 financial crisis, and many borrowers reached the end of their terms without any real plan to repay. The Financial Conduct Authority tightened the rules substantially afterwards: lenders must now assess that a borrower has a credible, realistic repayment plan, and most restrict interest-only to lower loan-to-value ratios.

In practice, mainstream lenders typically cap interest-only borrowing at 50% to 75% loan-to-value, so you will usually need a deposit of at least 25%, and sometimes 50%. Your repayment plan must be documented and plausible - accepted examples include investment portfolios earmarked for repayment, the expected sale of another property you already own, or a pension lump sum that will realistically materialise by the end of the term.

Relying on hoped-for house price rises, an inheritance that has not been confirmed, or future income growth generally does not pass muster. Lenders also check progress on the repayment plan periodically - if your investments fall short mid-term, they can require you to switch part or all of the loan onto repayment.

Buy-to-Let: Where Interest-Only Is the Norm

There is one corner of the market where interest-only remains standard: buy-to-let. Most landlord mortgages are interest-only by default, and the logic is different from residential borrowing. The property is an income-producing asset - the rent covers the interest - and the capital is expected to be repaid when the property is eventually sold.

Lenders assess buy-to-let affordability on rental income rather than the borrower's salary, usually requiring the rent to cover the mortgage payment at a stressed rate (often around 145% of the payment at a notional rate like 5.5%, though requirements vary). This stress test, plus typically higher deposits of 25% or more, is how lenders manage the risk.

For residential owner-occupiers, though, interest-only is now a specialist product rather than a mainstream choice. If you are buying a home to live in, expect the conversation with your lender or adviser to start from repayment - and to need a strong case to move away from it.

The End-of-Term Shortfall Risk

The great danger of interest-only is the end-of-term shortfall: reaching year 25 with no realistic way to repay the capital. If the investment plan underperformed, the other property could not be sold for enough, or life simply got in the way, the borrower faces selling the home - possibly at the worst possible moment - or extending the loan, if the lender and their age allow it.

This is not a rare edge case. Hundreds of thousands of interest-only mortgages taken out before the rule changes are still maturing, and the regulator has repeatedly flagged shortfall risk as a concern for borrowers who never set up a proper repayment plan.

If you already have an interest-only mortgage, review the repayment plan honestly and regularly. If there is a projected shortfall, talk to your lender early - switching part of the loan to repayment, overpaying where the deal allows, or remortgaging can all help, but they get harder to arrange the closer you are to the end of the term. This is general information, not personal financial advice - consider speaking to a qualified mortgage adviser about your own situation.

Run Your Own Numbers

The examples above use illustrative figures - your own deal will depend on the rate you can actually get, your deposit size, and your term. Our free UK mortgage calculator lets you model repayment and interest-only side by side so you can see exactly how the monthly payments and total interest compare for your situation.

Enter your property value, deposit, interest rate, and term to get an instant breakdown - no signup required.

• Open UK Mortgage Calculator

Sources

The figures and policy details in this article come from the following primary sources, checked at the time of writing.

• FCA: new mortgage rules (interest-only repayment plans)
• FCA: interest-only mortgages review