Interest-only repayment strategies: what lenders accept

With an interest-only mortgage you only pay the interest each month, and you have to pay off the entire loan at the end of the mortgage term¹. The monthly payment does not reduce the debt: the original loan amount does not go down, and a separate plan is needed to repay the capital². The Building Societies Association puts it plainly: the borrower is still responsible for repaying the full loan amount at the end of the mortgage term³.

That is why lenders do not simply take your word for it. Under the Financial Conduct Authority's rules, a lender may only enter into an interest-only mortgage, or switch a repayment mortgage onto an interest-only basis for all or part of its term, if it has evidence that the customer will have in place a clearly understood and credible repayment strategy with the potential to repay the capital borrowed and any interest reasonably expected to be accrued⁴. A lender must not accept speculative repayment strategies⁵.

So the question is not whether you have a plan, but whether the plan is one a lender will accept and evidence. This page sets out the strategies that appear in lenders' own criteria, how each is treated, and what happens when a plan falls short.

Interest-only means the loan is still owed at the end of the term

The structure is the same wherever you meet it. You pay back the interest on a monthly basis and repay the capital at the end of the mortgage term⁸. Monthly repayments just cover the interest, with the capital paid off at the end of the term in one go⁹. The Financial Ombudsman Service describes interest-only mortgages as ones where you only pay the interest each month but have to pay off the entire loan at the end of the mortgage term⁹.

Nothing about that changes if you never miss a payment. Leeds Building Society tells borrowers they will owe the full balance of the money they borrowed when the mortgage ends¹⁰. Kensington's glossary says that at the end of the mortgage term you will still owe the original amount you borrowed and must repay this in full¹¹. TSB says the same: at the end of the mortgage term you will still owe the full amount of the loan¹².

This is why the repayment strategy matters more than the interest rate. A repayment mortgage pays itself off through the monthly payment. An interest-only mortgage does not, and the money has to come from somewhere else at a date fixed when you took the loan out. The lender's interest is in whether that somewhere else is real.

The same shape appears in buy-to-let, where most mortgages are interest-only: you only pay the interest, and the amount borrowed is still owed at the end of the term¹³. It also appears in retirement interest-only mortgages, where you only pay the interest each month and the original amount borrowed is not repaid until later, typically when you die, move into long-term care, or sell the home¹⁴.

Repayment strategies lenders accept

Lenders publish the strategies they will consider, and the lists overlap heavily. Leeds Building Society names savings or investment products such as an endowment, pension or ISA, selling the property you have mortgaged, selling another property, or a combination of these⁶. Gen H gives savings, pension payments or selling the property at the end of the mortgage term as example strategies¹⁵. Hodge, for its Resi Retire mortgage, requires a repayment strategy such as sale of property (main residence or second home) or cashing in investments or assets¹⁶.

The Financial Ombudsman Service, which decides complaints about interest-only mortgages, says you can use money from different sources to meet the payment, such as an endowment policy or savings⁹. That is a useful statement of how the regulator's dispute body sees it: the plan does not have to be a single product.

What lenders will not accept is a hope. The FCA rule is explicit that a mortgage lender must not accept speculative repayment strategies⁵. In practice that means a plan has to be identifiable, evidenced and capable of producing the sum needed. Suffolk Building Society says that for loans taken on an interest-only or part interest-only basis a repayment strategy will need to be evidenced¹⁷. Accord says an acceptable repayment strategy must be in place to repay the loan at the end of the term, with evidence provided during the application process¹⁸.

Selling the mortgaged home or another property

Selling property is the strategy most borrowers fall back on, and the one lenders treat most carefully, because the money is not there until the sale happens.

Where the property being sold is not the one you live in, HSBC UK sets out how it values the plan: sale of other property, not the primary residence or the mortgaged property, is based on 75% of the current property value, less any outstanding secured borrowing. The evidence required is a mortgage statement or offer document dated within the last 35 days, a solicitor's letter or Register of Title, and a professional valuation by an RICS surveyor or a suitable automated valuation dated within the last 12 months⁷. That 75 per cent figure is the lender's own criterion, and it shows the principle: a lender will not count the full market value of an asset you have not yet sold.

Where the property being sold is the home you live in, the plan works but the consequence is different. Gen H lists selling the property at the end of the mortgage term among example strategies¹⁵. Hodge accepts sale of the main residence or a second home¹⁶. The practical point is that the sale realises the money and ends your occupation of the home at the same time, so the plan needs somewhere to live afterwards.

There is a wider version of this risk. Which? reports that thousands of borrowers on pre-credit crunch interest-only mortgages have no plan in place for repaying the capital, leaving them with the prospect of selling up and downsizing unless they can remortgage²⁰. Selling is a legitimate strategy; it is also the one that most often arrives by default rather than by design.

What lenders must check: a clearly understood and credible strategy

The test lenders apply comes from the FCA's mortgage rules. A lender may only enter into an interest-only mortgage, or switch a repayment mortgage onto an interest-only basis for all or part of its term, if it has evidence that the customer will have in place a clearly understood and credible repayment strategy, and, as far as it is reasonably able to assess at the time, that the strategy has the potential to repay the capital borrowed and any interest reasonably expected to be accrued⁴.

Two words carry the weight. "Credible" rules out plans that depend on something that may not happen. "Evidence" rules out plans that exist only in conversation. The rule that a lender must not accept speculative repayment strategies sits alongside it⁵.

The requirement reaches back to the advice stage as well. Where interest-only is identified as appropriate, the firm must ensure the customer is aware that he will have to demonstrate a clearly understood and credible repayment strategy to the mortgage lender²².

Lenders restate this in their own criteria. Suffolk Building Society requires a repayment strategy to be evidenced for interest-only or part interest-only loans¹⁷. Accord requires an acceptable repayment strategy in place to repay the loan at the end of the term, with evidence during the application¹⁸. Cambridge Building Society says a suitable repayment strategy is needed to repay the balance at the end of the term on interest-only parts of the mortgage²³. Suffolk Building Society also gives a worked example of what a lender will look for: a lender will require you to demonstrate you have an adequate repayment strategy, for example a pension lump sum or a second property¹⁹.

Can I switch part of my mortgage to interest-only?

Part interest-only is a recognised arrangement, and the FCA rule is written to cover it: a lender may only switch a repayment mortgage onto an interest-only basis for all or part of its term if the evidence test is met⁴. Suffolk Building Society sets criteria for part interest-only loans and requires the repayment strategy to be evidenced¹⁷.

Switching is also used as a breathing-space measure. The Mortgage Charter lets borrowers switch to interest-only repayments for 6 months²⁵. Which? describes a temporary switch to interest-only payments as one where you just pay the interest on your mortgage, without repaying the loan itself, for a set period of time²⁶. Borrowers who change the length of their repayment term or go on to interest-only plans can reverse that decision within six months²⁶.

There is a limit on when a lender will agree. Shelter Cymru says some lenders will refuse to allow you to pay interest only if your mortgage is already in arrears²⁷. Where a lender does agree to reduced interest payments, it will normally only do so if you are trying to sell your home, or your problems are short term and you will be able to meet full repayments soon²⁷.

Northern Ireland's advice service lists converting your mortgage to interest-only for a period as one of the options for clearing arrears²⁸. The same idea appears in the Mortgage Charter route, which is available across the UK²⁵.

If the aim is to reduce what you pay each month, there are other routes: reducing payments for a set period, charging interest only for a while on a repayment mortgage, a payment holiday, or extending the mortgage term to reduce payments, depending on your payment history and whether the difficulty is short or long term²⁹.

Using a pension or an ISA as the repayment vehicle

Savings and investment products are the most commonly named strategies, and lenders describe them in product terms.

Ecology Building Society says it offers an interest-only mortgage only when there is a qualifying repayment vehicle to support it, for example an established ISA, endowment policies or a Pension Plan³⁰. Santander says that if you change to an interest only mortgage you will need a suitable repayment plan in place to pay off the capital at the end of your term, for example from a mortgage-related endowment policy or ISA³¹. Experian says lenders may need evidence of a plan to pay off the full amount at the end of the term, called a repayment vehicle, such as an investment, endowment policy, or ISA³².

A pension can serve the same purpose. Suffolk Building Society gives a pension lump sum as an example of an adequate repayment strategy¹⁹. Shelter Cymru describes a pension-scheme mortgage, where you use part of your pension fund to pay off the loan⁸.

The risk with any investment-backed plan is that the value at the end is not guaranteed. That is precisely the gap the FCA's "credible" test is aimed at, and it is why lenders want the plan evidenced rather than assumed.

What happens if my repayment strategy falls short at the end of the term

You still owe the money. The Building Societies Association states that the borrower is still responsible for repaying the full loan amount at the end of the mortgage term³. Cambridge Building Society frames the same point from the lender's side: a suitable repayment strategy is needed to repay the balance at the end of the term on interest-only parts of the mortgage²³.

If the plan will not cover the balance, the options are the ones that apply to any mortgage shortfall. AIB (GB) lists switching to a capital and interest (repayment) mortgage, using savings to reduce the overall amount, making overpayments, and considering extending the term along with switching to capital and interest repayments, depending on your circumstances³³. AIB (NI) gives a similar list and adds selling the property, which it does not recommend³⁴.

The earlier this is addressed, the more of those options remain open. A shortfall discovered a year before the term ends can be met by overpaying, extending the term or remortgaging. A shortfall discovered at the end of the term is a lump sum that has to be found.

Reviewing the plan during the term

The rules bite hardest at the point of lending or switching, but the plan does not stop mattering afterwards. Coventry Building Society tells borrowers they will need to review their repayment plan regularly to make sure it is on track and that they will have enough to repay the loan²⁴. Kensington publishes guidance for existing interest-only borrowers³⁵.

Lenders also describe the arrangement in their general literature. West Brom says interest only loans usually allow the repayment of interest only for the whole mortgage term, with the capital balance paid off at the end of the mortgage term via a repayment plan such as investments or savings³⁶. Cumberland Building Society says that to repay an interest-only mortgage you will need to ensure you have a suitable repayment strategy to pay off the mortgage at the end of the agreed term³⁷. Yorkshire Building Society says you will need to repay the money borrowed for the home at the end of the term with a repayment strategy³⁸.

If the plan is not on track, the options are the ones set out above, and they are easier to use early. Free, impartial help is available: the Financial Ombudsman Service decides complaints about interest-only mortgages⁹, and debt advice charities and the MoneyHelper service can talk through arrears and shortfalls. Shelter Cymru's guidance covers repayment options and what happens when a mortgage is in arrears²⁷.

How an interest-only period on a personal loan is different

The phrase appears outside mortgages too, and the setting changes what it means. AIB (GB) describes an interest-only period on a personal loan as one where you will only pay the interest owed on your personal loan during this period and not the capital amount owed³⁹. Crowd2Fund describes an interest-only loan as one where the debt is repaid at the end of the term⁴⁰.

The Mortgage Charter, which covers mortgages, lets borrowers switch to interest-only repayments for 6 months, and borrowers who change the length of their repayment term or go on to interest-only plans can reverse that decision within six months²⁶. Personal loans are not covered by the Mortgage Charter, and the FCA's interest-only lending rule applies to mortgages, not to personal loans⁴.

The practical difference is what happens if the plan fails. A mortgage is secured on your home, so a shortfall at the end of the term carries the risk of repossession. A personal loan is unsecured, and the lender's remedies are different. The mechanics of paying interest only look alike; the consequences do not.