Interest only versus repayment mortgages
There’s all sorts of jargon to get to grips with when considering mortgages, but one of the most crucial matters to grasp is the difference between an interest-only and a repayment mortgage.
Interest-only mortgages only require you to pay the lender interest charges each month – the money you originally borrowed is then repayable in one lump sum at the end of the term of the loan. You are expected to have some sort of savings vehicle in place to produce the funds to make this repayment.
With a repayment mortgage, on the other hand, you pay interest charges each month but also make a small repayment of the original advance. At the end of the term of the mortgage – usually 25 years – you’re debt-free with no more to pay.
Interest only mortgages are more risky
So which type of deal is best? Well, there’s no right answer to that question – it really depends on your attitude to risk.
With an interest-only loan, the additional savings you make are invested in order to get you to the final total required. The returns on these investments plus, very often some tax breaks, may mean repaying the capital borrowed costs you less in total monthly contributions. And on the day the mortgage finally falls due, you may even find you have additional cash left over – a lump sum to spend as you see fit.
Interest-only mortgages got a bad name during the endowment scandal. Many borrowers were sold endowment funds they thought were guaranteed to repay their mortgages, only to find many years down the line that they actually faced a shortfall.
That is the risk of an interest-only mortgage. If the investments you make disappoint, you may not have enough money to cover your debt. In which case you’ll have to make additional payments you weren’t expecting.
In practice, such a shortfall should not come as a horrid last-minute surprise. If you do opt for the interest-only route, your mortgage lender will expect to see evidence that you are making provisions to repay the capital. And the provider of the savings vehicle you are using should provide you with regular updates on your progress – including warnings if it thinks you are in danger of falling short of the sums required (and advice on what to do to make up the ground).
Moreover, you may be able to get a little extra help from the taxman. If you use tax-efficient saving products to save for the final payment, such as individual savings accounts or even pension schemes, you’ll get a boost from their tax-free status.
Fewer interest only mortgages available
Even so, interest-only products are not for the faint-hearted. Where interest-only mortgages sold with an endowment policy were once the most common type of home loan, the majority of people these days prefer the security of a repayment mortgage.
Many lenders have also decided to stop offering interest-only mortgages or will only offer them to certain customers. So the range of mortgage deals available to you may be more limited if you opt for an interest only mortgage. A Which? Mortgage Adviser will be able to advise you on whether an interest only mortgage is the right option for you.
Ask for mortgage advice
If you are considering the interest-only route, you should take impartial and expert advice – on the savings vehicles you plan to use to repay the capital and the underlying mortgage product too.
You can speak to a Which? mortgage adviser by calling us on 0117 981 7787 – or request a call back. Our advisers look at every mortgage from every available lender, and because they’re paid a salary – not a sales commission – you can have confidence that you’ll receive truly impartial advice.