Paying off a huge loan like a mortgage is no easy feat. That is why flexibility is key and why all homeowners and even commercial property owners need to at least be aware of the interest-only mortgage.

By knowing your options, you can better navigate periods of financial stress. You can also make different decisions for your future. Interest-only mortgages can be used in a variety of ways, and not just as a way to lower repayments during a tough time, such as when you lose a job.

If you’ve only just heard about the interest-only mortgage, however, and have asked yourself what is a interest-only mortgage and when you’d even need it, then this guide is for you. So dive on in and learn everything there is to know about interest-only mortgages:

What is Interest-Only Mortgage?

So, what’s an interest only mortgage exactly? It’s what it sounds like on the tin. This means that with an interest-only mortgage, you only pay off the interest and not the principal or loan amount.

Still not sure?

Mortgage repayments broken down

Interest payments are the interest that builds up on top of the loan amount.

The principal is the loan itself.

A repayment mortgage (which is a standard mortgage) has you repay the loan amount in monthly instalments over a period of 25 to 30 years usually (it can be less). On top of those repayments, you also pay interest.

Interest is calculated based on how much you owe (the principal) in total. This means that as time goes on, your interest will actually decrease.

For example, say your interest rate is 3%, and your loan total is £100,000. This means that you need to pay £3000 for the first year.

If you have a 30-year repayment, that means you’d pay £3333 per year. After 15 years, you’ll have paid off £50,000. Since your principal is now half what it used to be, your mortgage interest rate payment will instead be £1500 for the year.

With an interest-only mortgage, you only pay the interest on the loan, not the loan’s payments. This could mean that your loan period increases, but that isn’t always the case.

Reasons to Get an Interest-Only Mortgage

There are many reasons to get an interest-only mortgage.

1. You need to briefly reduce outgoing costs due to financial hardship (you’ve lost a job, you need to make big payments towards somewhere else, etc).
2. You want to put the money that goes towards your mortgage towards an investment account or other option.
3. You want to keep payments low while you remodel your property.
4. You want to take out a lifetime mortgage but pay off interest as you go.

To recap, getting an interest-only mortgage is often done to make payments more manageable, to put the money towards another investment, or if you plan on repaying the principal when you sell the home.

Here are some example scenarios of when an interest-only mortgage can be in your best interest:

1. You are house flippers, meaning you buy a run-down property, fix it up, and then sell it. With an interest-only mortgage, you can keep your outgoings low so you can balance living and business costs.
2. You are over 55 and want to take equity out of your home. You want to cover the interest of the loan while you can so you can pass down as much as possible to your heirs.
3. You want to invest money into stocks and put the money that would go towards the principal into a savings account or the stock market. At the end of the interest-only period, you pay off more of the principal (if you can, as your capital is always at risk when you use this method).
4. You have lost your job and want to reduce your outgoings to better support yourself while you are job hunting.

Getting an Interest-Only Mortgage

How you get an interest-only mortgage depends on whether or not you already have a mortgage.

Switching to an interest only mortgage

It is far easier to switch to a temporary interest-only mortgage than any other option. This is going to be more available to those who have already paid off a fair share of their loan and have a lower loan-to-value (LTV).

Even then, however, the government’s Mortgage Charter helps protect you. Thanks to this charter, you have the right to switch to an interest-only mortgage for a brief six months. This is to help if you’ve lost your job or have suddenly taken on a big cost, like the care of a loved one.

Remortgaging to an interest-only mortgage

If you’re close to the end of your fixed term period, you may want to consider a longer interest-only mortgage when you remortgage. You’ll want a broker to help connect you to a wider range of lenders for this option, and even with a remortgaging approach, you will need to pay off the principle when the agreement ends.

Getting an interest-only mortgage at purchase

Interest-only mortgages are usually only available at purchase if you can put forward a large deposit between 20 to 40%, if you have a strong financial position, and if you have a solid repayment plan.

This means that those looking to get an interest-only mortgage at the start are largely investors, buy-to-let property owners (who need to fix up the property before they can rent it out), and home flippers.

You may also be able to get an interest-only mortgage if you have the deposit but are currently paying a second mortgage. In this instance, you will be planning on selling that property soon. Alternatively, you might prefer a bridging loan.

Frequently Asked Questions

What if I can’t pay off my interest-only mortgage?

If you can’t pay off even your interest-only mortgage, then you will default entirely on your loan. You might be able to remortgage to a lower interest-only mortgage, though this is rare. It is better to look into actively selling your property now rather than have your lender claim it and sell it at auction.