Interest-only mortgages – a good idea?
How they work, should you get one and how to repay
Interest-only mortgages are far less common than they used to be – making up just 10% of all mortgages. They're also much harder to get, so if you're considering one then it will be important to understand how they work and what lenders will want to see. This guide explains what interest-only mortgages are and who can get one.
Already got an interest-only mortgage?
This guide also explains:
How do interest-only mortgages work?
Broadly speaking, mortgages fall into two different categories: 'capital repayment' and 'interest-only'.
Here's how they differ:
Capital repayment mortgages
The vast majority of mortgages these days are capital repayment. Here, each month you repay some of the money you've borrowed, plus interest, until the mortgage is completely repaid (which is, say, after 25 years).
See our What mortgage to choose? guide for more on how capital repayment works.
Interest-only mortgages
An interest-only mortgage works differently to capital repayment. Here, you just repay the interest each month, not the capital you've borrowed. This means:
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You don't chip away at the actual debt. So, when the term ends on a £150,000 interest-only mortgage – for example, after 25 years – you'd still owe £150,000.
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You'll normally have to repay what you borrow in one lump sum. So when you apply for an interest-only mortgage, you'll need to show the lender that you have got a convincing plan for paying off the debt at the end of the mortgage term.
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The monthly repayments are smaller than with capital repayment.
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But over the long-term, interest-only is more expensive than capital repayment. Because if you're not reducing the debt each month, more interest is able to accrue.
To get a sense of how the cost of interest-only and capital repayment mortgages compare, use our Basic mortgage calculator (switch between the calculator's 'interest-only' and 'repayment' options) – or simply read on as we'll discuss this in more depth later.
Who can get an interest-only mortgage?
Getting accepted for any type of mortgage is tough.
You'll improve your chances of mortgage acceptance if you've got a decent deposit, can prove you could afford the repayments, and have a healthy-looking credit report. See our Boost your mortgage chances guide for 18 ways to get yourself mortgage ready.
Yet there'll be extra hoops to jump through if you apply for an interest-only mortgage – mainly because the eligibility criteria is tougher. Here are some examples of this:
You'll need at least a 20% deposit – in some cases nearer to 50%. On a £300,000 property, a 20% deposit is £60,000. Yet even then there aren't many deals available – there are more if you've got a 25%, 30% or 40% deposit (some lenders ask for 50%).
Fewer lenders offer interest-only mortgages, so your choice is limited. Compared to capital repayment, there are far fewer lenders in the interest-only market, currently including: Halifax, NatWest, Yorkshire Building Society, plus some smaller lenders.
Interest rates tend to be higher than capital repayment. You can see what kind of interest-only mortgage rates are available by using our Mortgage best buys tool.
You're more likely to be accepted if you're a higher earner. Lenders tend to have higher minimum income requirements for interest-only. For example, Halifax and NatWest both require at least £75,000 for solo applicants, £100,000 for joint applicants.
You'll need cast-iron evidence of how you'll repay the mortgage in future. A lender will want to be confident you'll be able to repay the mortgage lump sum at the end of the term. The bigger the mortgage, the tougher proving this could be – more on this below.
How can I prove I'm able to repay the mortgage in future?
In technical terms, this is referred to as having a 'repayment vehicle' in place.
The repayment vehicles deemed acceptable vary by lender, and some lenders allow you to combine more than one repayment method. The methods could include:
🪙 Savings. For example, if you've got – or expect to have – a large lump sum of savings. Top savings accounts, Regular savings accounts and Best cash ISAs might help here.
🪙 Stocks and shares, or other investments. Our Stocks and shares ISAs, Robo investing, Funds and Share dealing guides might help here.
🪙 Other assets and properties. For example, if you own – or you expect to come into ownership of – another property or valuable asset.
🪙 Pension pots. Where you expect to have a large pension pot in future and could access the money by the time mortgage term expires. See our guides on Pensions.
How much do interest-only mortgages cost?
While you may pay less per month for an interest-only mortgage than for a capital repayment mortgage, they're vastly more expensive overall. And the longer you have an interest-only mortgage for, the more expensive it gets.
The difference in cost between the two types of mortgage over, say, 25 years could easily be £10,000s. It may even be £100,000+. Got a 30-year+ mortgage term? The difference in cost will be even bigger.
So, even if you're confident you'd be able to get an interest-only mortgage, you should seriously consider whether it's wiser to choose a capital repayment mortgage.
Why an interest-only mortgage can cost £10,000s extra over time
While you may pay more per month if you've got a capital repayment mortgage, at the end of the mortgage term you'll have cleared the debt and be mortgage-free. Whereas with an interest-only mortgage, at the end of the mortgage term you'd still owe the debt in full.
For example, let's say you borrow £200,000, for 25 years, with an interest-only mortgage. Even though you'll repay the interest each month, after 25 years you'd still owe £200,000.
Furthermore, as your mortgage balance isn't reducing, you'll pay more interest overall. That's because interest is charged on a mortgage balance which remains static, unlike capital repayment where the balance gradually reduces (meaning less interest can accrue).
Let's say you borrow £200,000, at 5% interest, for a period of 25 years. Here's what you'd repay depending on whether you'd chosen capital repayment or interest-only:
Each month. With capital repayment you'd repay £1,170 per month, while with interest-only you'd repay £834 per month – that's a difference of £336.
Over 25 years. With capital repayment, you'd repay £350,882 overall, of which £150,882 is interest. With interest-only, you'd repay £450,182 overall, of which £250,182 is interest – a difference of £100,000 in interest.
Where the mortgage term is longer than 25 years, the difference in cost would be even more pronounced than the example above, as interest will have more time to accrue. Use our Basic mortgage calculator to further explore how the costs compare.
One way of offsetting the cost of an interest-only mortgage is by putting money that's not going towards mortgage repayments into savings. Our Savings calculator shows how much interest it's possible to earn, plus take a look at our Best savings account guide.
Another way to cut the cost is by making regular mortgage overpayments, which would have the effect of reducing your mortgage balance (more on this in the chapter below).
How to reduce the cost of an interest-only mortgage?
Technically an interest-only mortgage doesn't need to be repaid until the term ends – for example, after 25 years. But from a money-saving perspective, you should consider paying off the mortgage (at least in part) well before this.
The risk of not chipping away at the balance is you'll be left with a large lump sum to pay off in one go. You may need to sell your home in order to do this – perhaps if your repayment plan doesn't work out.
There are different ways you can start repaying your interest-only mortgage early. We discuss these below, though be aware that options two, three and four require formal agreement from your lender, meaning you'll need to pass an affordability check.
If you want to learn more about how you can start repaying your interest-only mortgage, it's worth contacting your lender and discussing the options.
Option 1. Make regular mortgage overpayments
Many lenders allow you to overpay a mortgage, including interest-only mortgages – in other words, repaying by more than your contracted monthly payment.
Regularly overpaying can help you to save £1,000s in interest and potentially clear your mortgage sooner, possibly by years. This is because your mortgage balance reduces more quickly, meaning less interest is able to accrue. However, be aware that:
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There's often a restriction on how much you can overpay by (typically 10% a year). Bust this limit and you'll likely be hit by an early repayment charge.
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If you've got other, more expensive debts, it's often worth clearing those first.
Full pros and cons, plus how it works, in our Should I overpay my mortgage? guide.
Option 2. Switch to capital repayment for the rest of the term
It may be possible to switch your mortgage from interest-only to capital repayment for the remainder of the mortgage term. Doing this means your monthly repayments would need to increase, likely by a significant margin if you do stick with the same mortgage term.
Unlike making regular mortgage overpayments, this would be a formal change to your mortgage that locks you in to new repayment terms, so the lender would need to agree.
Crucially, you'll need to pass an affordability test before the lender says yes.
Worked example: switching to capital repayment
You've got an interest-only mortgage of £125,000, paying 3% interest, over a term of 25 years. Your monthly repayments are £313.
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If you remain on interest-only, over 25 years you would repay £218,750.
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If you switch to capital repayment after 10 years, your monthly payments would increase to £863 (an extra £550). But in total over 25 years you would repay £192,804 (a saving of £26,000).
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If you switch to capital repayment after 15 years, your monthly payments would increase to £1,207 (an extra £900). But in total over 25 years you would repay £200,990 (a saving of £18,000).
Option 3. Switch to capital repayment AND extend the term
If you'd like to switch to capital repayment but would struggle if your monthly payments increased significantly, you could extend your mortgage term at the same time as switching.
This would limit how much your monthly payments increase by. However, it would also limit the benefits of switching to capital repayment. In other words, you'd make a bigger long-term saving by switching to capital repayment and keeping your mortgage term the same.
In fact, switching to capital repayment and extending the term could even mean the overall cost of your mortgage becomes more expensive than simply sticking with interest-only. The trade-off is that at the end of the term there won't be a lump sum to repay.
Worked example: switching to capital repayment and extending
You've got an interest-only mortgage of £125,000, paying 3% interest, over a term of 25 years. Your monthly repayments are £313.
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If you remain on interest-only, over 25 years you would repay £218,750.
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If you switch to capital repayment after 15 years and extend your term by five years to 30, your monthly payments would increase to £863 (up £550). But in total, over 30 years you would repay £211,704 (a saving of £7,046).
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If you switch to capital repayment after 15 years and extend your term by 10 years to 35, your monthly payments would increase to £693 (up £380). But in total, over 35 years you would repay £222,516 (an increase of £3,766).
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If you switch to capital repayment after 20 years and extend your term by five years to 30, your monthly payments would increase to £1,208 (up £895). But in total, over 30 years you'd repay £219,710 (an extra £960).
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If you switch to capital repayment after 20 years and extend your term by 10 years to 35, your monthly payments would increase to £864 (an increase of £551). But in total, over 35 years you'd repay £230,244 (an extra £11,494).
Option 4. Repay a lump sum AND switch to capital repayment
Another option is to pay off a lump sum and simultaneously switch to capital repayment for the rest of the mortgage term.
Beyond paying off your interest-only mortgage early in one fell swoop, this is the most cost-saving measure. However, the amount you save will be reduced if you also extend your mortgage term at the same as paying a lump sum and switching to capital repayment.
Be aware that while most lenders allow mortgage overpayments, this is often capped – typically at 10% each year – so you'll need to think carefully about the lump sum. Bust this limit and you might be hit with an early repayment charge, which can cost £1,000s.
Yet even if you would have to pay an early repayment charge, it still might make financial sense to reduce your mortgage balance with a lump sum. If unsure, speak to your lender.
Worked example: pay lump sum and switch to capital repayment
You've got an interest-only mortgage of £125,000, paying 3% interest, over a term of 25 years. Your monthly repayments are £313.
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If you remain on interest-only, over 25 years you would repay £218,750.
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If you overpay by £12,500 and switch to capital repayment after 15 years, your new monthly payments would be £1,086 (an increase of £773). But in total, over 30 years you would repay £199,000 (a saving of £19,750).
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If you overpay by £50,000 and switch to capital repayment after 15 years, your new monthly payments would be £724 (an increase of £411). Even if you had to pay, for example, a £3,000 early repayment charge, in total over 30 years you would repay £196,098 (a saving of £22,652).
What if I fail the affordability checks?
Switching to capital repayment will almost certainly involve an affordability check if your monthly payments would increase, as your lender must check you could afford it.
As there's no guarantee you'll pass this test, there's no guarantee you'll be able to switch.
Yet even if you do fail the affordability test – or don't think it's worth applying as you believe you'd fail – it's still worth checking with your lender what other options it might offer.
Some lenders allow switching to 'part-part'. This is where you repay a small amount of capital each month in addition to your normal monthly repayments. Others may let you switch mortgage deal, penalty-free, to one that has a better interest rate or more flexibility.
Alternatively, if your lender won't agree to you changing your mortgage, you could simply overpay your mortgage on a regular basis. This has a similar effect to switching to capital repayment in that it chips away at the debt, but has the added flexibility of not tying you in to higher monthly repayments (in other words, you can stop regularly overpaying at any time).
What if I can't repay an interest-only mortgage?
If your circumstances have changed, it may be that you're no longer confident about how you'll repay your interest-only mortgage (the lump sum) once the term ends. In other words, you're facing a payment shortfall.
Don't just ignore it if you're in this situation. The best thing to do is get in touch with your lender – and sooner rather than later. The quicker you act, the more options your lender is likely to offer you.
Some of the options your lender might offer include:
Extend your mortgage term and switch to capital repayment (partly or fully).
Extend your mortgage term so you can sell your home or cash in investments.
Remortgage on an interest-only basis (likely to be age dependent).
Repay the mortgage in a number of lump sums rather than in one go.
Simply speaking to your lender about your situation will have no impact on your credit report, so don't let worries like that hold you back. And remember, repossession – where a lender takes ownership of your home – is treated as a measure of last resort by lenders, so don't ignore the situation out of a misplaced fear you'll immediately lose your home.
Where your lender can't help, you may need to consider the options discussed below.
Alternatively, you can seek free debt advice from the likes of Money Helper, Citizens Advice or StepChange. An advisor will be able to talk you through your options.
Other options – switch lenders, retirement interest-only mortgages and equity release
Other ways of repaying an interest-only mortgage can include getting a capital repayment mortgage from another lender, applying for a retirement interest-only mortgage (RIO), or tapping into your home's value through something known as equity release.
If you pursue any of these avenues, the cash you raise would be used to pay off your interest-only mortgage, after which you'll be left with a new mortgage to repay (though with equity release and RIOs this won't need repaying until you die or go into long-term care).
For an explanation of how these work and, importantly, how they compare in terms of cost, see our guide on Getting a mortgage when you're older or in retirement.
Where you want to explore remortgaging or a RIO, you should speak with a mortgage broker. If you're considering equity release, you'll need to speak with an equity release adviser – our Should you equity release? guide explains where you can find one.
Struggling to work out which course of action is best? You can free debt advice from the likes of MoneyHelper, Citizens Advice and StepChange.
Nearly 1 million interest-only mortgages need repaying
A report published by the Financial Conduct Authority suggests there are 990,000 homeowners with interest-only mortgages (including 245,000 part-part mortgages).
Most of these are set to expire over the next 10 years: 51,000 in 2027, 72,000 in 2031 and 77,000 in 2032. The median amount owed is £140,000, while almost 20% owe more than £300,000.
The report suggests a significant number of these borrowers are unsure how they'll eventually repay their mortgage. If that's you, it's wise to take action now to reduce the cost of the mortgage.
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