Repayment vs interest-only mortgage: how the two compare

A repayment mortgage is the standard way to buy a home in the UK: each monthly payment covers the interest and pays off a slice of the loan, so the balance falls to zero by the end of the term. An interest-only mortgage works differently. Your monthly payment covers only the interest, so it is lower, but the amount you borrowed does not shrink at all. At the end of the term you still owe the whole sum and have to repay it in one lump sum¹.

That single difference drives everything else. On a £250,000 mortgage at 3% over 25 years, a repayment deal costs £1,186 a month and clears the loan, with £105,800 paid in interest. The same £250,000 on interest-only costs £625 a month, but the interest bill over the 25 years is £187,500, and the £250,000 itself is still outstanding at the end³.

Interest-only is not a niche product. It is the norm in buy-to-let, common for expat borrowers, and available to older borrowers through retirement interest-only mortgages, where the loan is typically repaid from the sale of the home⁴.

How a repayment mortgage and an interest-only mortgage work

With a repayment mortgage, which is by far the more common type of deal, you pay off a bit of the loan as well as some interest as part of each monthly payment¹. Shelter Cymru puts it simply: you pay back the capital and the interest together². Because the balance falls every month, the interest charged on that balance falls too, and the loan is designed to reach zero at the end of the term.

An interest-only mortgage reverses that. You pay back the interest on a monthly basis and repay the capital at the end of the mortgage term². StepChange's definition is that interest-only requires a person to make payments to cover the monthly interest on the total mortgage balance over an agreed term, and at the end of the term the full capital will need to be repaid⁹. The original loan amount does not reduce, so a separate plan, sometimes called an exit strategy, is needed to repay the capital at the end¹⁰.

The practical consequence is that the two products behave very differently over time. On a repayment mortgage the balance shrinks steadily, so the interest you are charged each month falls as the years pass. On interest-only the balance stays where it started, so the interest charge stays broadly the same for the whole term unless the rate changes.

Monthly payments: interest-only is lower, repayment is higher

Monthly repayments on an interest-only mortgage are lower than on repayment mortgages, sometimes called capital repayment mortgages¹¹. The reason is straightforward: you are not repaying the money borrowed at the same time, so the payment only has to cover interest¹². The Nottingham's own comparison puts it plainly: repayment mortgage payments are higher because you are paying capital and interest, while interest-only payments are lower but you pay less off the balance¹³.

The gap can be large. On a £250,000 mortgage at 3% over 25 years, the interest-only payment is £625 a month and the repayment payment is £1,186 a month³. On a £200,000 loan at 4.5% over 25 years, an interest-only payment is around £750 a month¹⁴.

What that lower payment buys is a bigger bill later. Interest-only costs more in interest payments over the life of the loan because the balance does not reduce¹⁵. On a £200,000 loan at 4.5%, the difference in interest paid over 25 years compared with a repayment mortgage can be over £90,000¹⁴. Experian's guidance makes the same point: you will usually pay more interest overall than with a repayment mortgage, because the amount you pay interest on does not go down¹⁶.

Rates matter as much as the repayment type. On a £130,000 mortgage over 25 years, a 1.5% rate gives a monthly repayment of about £520, a 2.5% rate gives £583, and a 3.5% rate gives £651¹⁷. A quarter point rise in the base rate adds £325.80 a year to the cost of a £200,000 mortgage over 20 years, and a half point rise adds £819.24 a year to a £250,000 mortgage over 20 years¹⁸.

Interest-only needs a plan to repay the loan at the end

An interest-only mortgage is only available if you can show how you will repay the capital. The rule is set by the regulator: a mortgage lender may only enter into an interest-only mortgage, or switch a repayment mortgage onto an interest-only basis, 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 accrued⁷. That rule came out of the Mortgage Market Review, which introduced the principle of only allowing a borrower to take out an interest-only mortgage where there is a credible repayment strategy in place¹⁹.

In practice, lenders ask for a repayment plan before they will lend. Nationwide states that to apply for an interest-only mortgage you will need a mortgage repayment plan in place²⁰. TSB's guidance is that you will need to make sure you have put plans in place to pay off everything you owe at the end of your term, for example an investment or savings plan²¹.

Acceptable strategies vary. The regulator's examples include regular deposits into a savings or investment product, periodic repayment of capital from irregular sources of income, and the sale of assets such as another property or other land²². For many residential interest-only mortgages, acceptable strategies include a savings plan, an investment portfolio, a pension or other assets you plan to sell³. Leeds Building Society lists using a savings or investment product such as an endowment, pension or ISA, selling the property you have mortgaged, selling another property, or a combination of these²³.

Where interest-only is common: buy-to-let, expat and retirement mortgages

Interest-only borrowing is standard in several parts of the market where a repayment mortgage is either unusual or unsuitable.

Buy-to-let. Buy-to-let mortgages are generally interest-only rather than repayment⁴. The rules on buy-to-let interest-only mortgages are less strict than for residential ones, because interest-only borrowing is standard for these purchases³. HSBC notes that interest-only mortgages are commonly chosen when buying to let²⁴. Landlords often prefer the lower monthly cost and plan to repay the loan by selling the property, sometimes decades later.

Expat mortgages. Expat mortgages are available on an interest-only basis²⁵. Borrowers living abroad may have income in another currency or plan to return to the UK, and interest-only keeps the monthly commitment lower.

Retirement interest-only. A retirement interest-only mortgage is a specific product defined in the regulator's handbook: an interest-only mortgage which requires the interest accruing under it to be repaid in full over the stated term, entry into which is restricted to older customers above a specified age, and under which the lender is not entitled to seek full repayment of the loan until one or more specified life events occurs, unless the customer breaches their contractual obligations²⁶. In other words, you pay interest monthly and the capital is repaid later, usually when the home is sold.

Interest-only mortgages are available with fixed and variable rates, and typically available for both purchases and remortgages³.

Retirement interest-only mortgages: paid off when the home is sold

Retirement interest-only mortgages work differently from a standard interest-only loan because there is no fixed end date that forces repayment. With most RIO mortgages, you only repay the loan when you sell your property, move into residential care or die⁸. Lloyds Bank describes the same structure: you only pay the interest each month, and the original amount you borrowed is not repaid until later, typically when you die, move into long-term care, or sell the home²⁷. The Melton's version is that there is no set end date for the settlement of the loan, and it is repaid by selling the house when you either decide to sell, go into long term care or pass away²⁸.

Some RIO mortgages allow repayment of some capital as well as interest, cutting the loan size over time²⁹. Lloyds Bank notes that with certain retirement interest-only deals you might also be able to pay off some of the actual mortgage as well as the interest²⁷.

The amount you can borrow is based on an affordability assessment looking at income and outgoings once your only sources of income are from pensions, savings or investments, and not employment⁸. The regulator's rules allow a lender to assess affordability on the basis of payment of interest only over the term, and it need not consider the cost of the repayment strategy as committed expenditure³⁰. For a retirement interest-only mortgage, the acceptable repayment strategy is the sale of the property which is the subject of the agreement³⁰.

Can I borrow as much on interest-only as on a repayment basis?

Usually not as much. Lenders typically apply a lower maximum loan to value on interest-only borrowing than on capital repayment. As an example, you might be able to borrow 50% of the value of your property on an interest-only basis, or 65% on a capital repayment basis⁸. The exact limits vary by lender, by the type of mortgage and by the repayment strategy you put forward.

That difference matters most for anyone weighing up how much they can spend on a property. A lower maximum loan to value on interest-only means a larger deposit is needed for the same purchase price, or a lower purchase price for the same deposit. It also means that switching an existing mortgage from repayment to interest-only, or the other way, can change what the lender is willing to lend against the property.

The regulator's rules also shape what counts as an acceptable plan. For a shared equity credit agreement or a retirement interest-only mortgage, the sale of the property which is the subject of the agreement is an acceptable repayment strategy³⁰. For standard residential interest-only, the lender will look at savings, investments, pensions and the sale of other assets²².

Can I switch from interest-only to a repayment mortgage?

Many lenders will let you switch from interest-only to repayment¹³. Some make it straightforward and free. Kensington states that there is no charge to switch your mortgage from interest only, or part and part, to a capital repayment mortgage, and a term change can be assessed at the same time³¹.

The monthly payment will rise, because you start repaying capital as well as interest. That is the trade-off: a higher payment now in exchange for clearing the loan by the end of the term.

There are other routes. When you remortgage you can change to a repayment plan, because you are starting a completely new mortgage³². Some lenders may also allow you to split your mortgage between interest-only and repayment, known as a part and part mortgage³². On a part and part mortgage, repayments every month are lower than with a repayment mortgage, but the total interest is lower than with an interest-only mortgage³³.

If you are struggling with payments, a temporary switch to interest-only is one option a lender may offer: you just pay the interest on your mortgage, without repaying the loan itself, for a set period of time³⁴. That reduces the monthly cost for a while but does not reduce the debt.

What happens if I can't pay off an interest-only mortgage at the end of the term?

At the end of the mortgage term you will still owe the original amount you borrowed and must repay this in full³⁵. The loan amount must be paid in full when the mortgage term ends³⁶. If on an interest-only basis, you would need to repay the capital on expiry of the mortgage term³⁷.

If the repayment plan has not produced enough, the shortfall is yours to cover. The lender can pursue the debt, and the options are broadly the same as for any mortgage difficulty: switch to a repayment basis if the lender allows, extend the term, sell the property, or use savings and investments. The Financial Ombudsman Service handles complaints about interest-only mortgages where a borrower believes they were not properly told about the need to repay the capital³⁸.

Overpaying and other ways to clear the loan faster

If you are on a repayment mortgage, overpaying reduces the balance faster and cuts the interest bill. A £5,000 overpayment on a £200,000 mortgage over 25 years at 3% would mean the mortgage is repaid after 24 years and one month, saving £5,446 in interest³⁹. A £20,000 overpayment on the same mortgage would mean it is repaid after 21 years and 6 months, saving £20,155 in interest³⁹.

The effect of the balance shrinking is visible in the numbers. On a £300,000 repayment mortgage over 25 years at 5%, £14,860 of the first year's payments goes on interest, which is 71% of what you pay; by year 25 only 3% of the payment is interest⁴⁰. That is the mechanism that makes repayment mortgages cheaper overall: the interest charge falls as the capital is paid down.

Overpaying is not the only option. Whether to overpay the mortgage or save the money instead depends on the rate you are paying on the mortgage against the return available on savings⁴¹. Some mortgages carry early repayment charges, so it is worth checking the terms before making a large overpayment.