Interest-only Mortgage vs. Repayment Mortgage
Lower Mortgage Payments for First-Time Buyers
Dec 21, 2008
An interest-only mortgage is a great way of ensuring lower mortgage payments. It is hard for a first-time buyer to save up enough for a house deposit and get on the property ladder so keeping monthly costs down is a priority, especially for those who are just starting a professional career.
What is an Interest-only Mortgage?
A borrower agrees to make a series of lower mortgage payments for a defined mortgage term, but only repays the interest and not the original capital borrowed. They are responsible for setting up a separate repayment vehicle, such as an ISA, to repay the capital at the end of the mortgage term.
Advantages of Interest-Only Mortgages
- Lower mortgage payments. Not paying off the capital over the mortgage term means that lower mortgage payments are possible.
- Better than renting. First-time buyers are able to benefit from long term capital appreciation as renting is dead money.
- Able to change to a repayment mortgage later. A first-time buyer trying to get on the property ladder may struggle with high monthly repayments, but this may change following career progression. Many borrowers switch to a repayment mortgage when finances allow.
- Known future inheritance. It may be that someone will be receiving money from inheritance later in life which can be used to clear the capital in full
- Investment property. Those with buy-to-let properties regularly opt for an interest-only mortgage rather than a repayment mortgage because they have bought solely for capital appreciation.
Disadvantages of Interest-only Mortgages
- Capital repayment. A repayment mortgage does make life harder in the short term, but the house is theirs at the end of the mortgage term.
- Need to set up a separate repayment vehicle. Setting up a repayment vehicle in the form of a lump sum pension payment or ISA is necessary. This may not cover the amount originally borrowed so a repayment mortgage may be preferred by the more cautious borrower.
- Fewer lenders offer interest-only mortgages. Lenders are far more restrictive when lending on an interest-only basis. Many cap the LTV at 75% or wish to see evidence that a repayment vehicle is in place.
- Negative equity. In a falling property market, it is vastly more likely that those with interest-only mortgages will experience negative equity.
Interest-only mortgages are a useful way of ensuring lower monthly repayments for first-time buyers or during financial difficulties. It is possible to change to a repayment mortgage when future circumstances allow.
Those who found this article useful may also wish to read about Fixed Rate Mortgages - Pros and Cons and Standard Variable Rate Mortgages - Pros and Cons.
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