What’s the difference between an interest-only mortgage and a repayment mortgage?
An interest-only mortgage is when your monthly repayments only cover the interest that’s building up on your loan. This means that when your mortgage comes to an end, you’ll have to pay your mortgage back in one lump sum.
On the other hand, around 65% of homeowners are on what’s called a repayment mortgage (according to Experian). This is when your monthly repayments cover both the interest and a contribution towards paying off the loan itself. By the end of a repayment mortgage, the idea is that you’ll have paid off the loan completely and you’ll finally own your house outright. Get in!
Why switch to a repayment mortgage?
Well, there are a few reasons. But first and foremost, a repayment mortgage could give you some peace of mind.
Huh? Peace of mind about what?
Well, if you can’t afford to pay back your interest-only mortgage in one lump sum, you’ll have to take out a new mortgage – or, if worst comes to worst, sell your house. Yep, you heard us right. It can be pretty nerve-wracking!
Switching to a repayment mortgage where you pay off the loan in monthly instalments can make your debt easier to manage. It’s a lot less likely that you’ll end up in a sticky situation later down the line!
That said, lenders (the people that give out mortgages) won’t give you an interest-only mortgage unless you have a solid plan for how you’re going to pay it back. This is known as a ‘repayment vehicle’ and can include plans like selling a buy-to-let property or paying into a savings account each month.
In other words, even though paying back the full loan as a lump sum might sound scary, you won’t usually be in this position unless you’ve proven you can handle it.
Should I switch from an interest-only mortgage to repayment?
That depends. Interest-only is probably a bigger risk than a repayment mortgage, but some of us are more willing to take risks than others.
Ultimately, only you can make the decision. But to help, here are some of the pros and cons of switching to a repayment mortgage.
- Clear repayment plan: A repayment mortgage will come with a clear plan that lays out how much you need to pay each month. This can make it easier to manage.
- Peace of mind: If you switch to a repayment mortgage, you won’t have the worry of paying back a big lump sum hanging over you.
- Own your house outright: With a repayment mortgage, you’ll own your house outright when your mortgage comes to an end. This means you won’t have to sell your house to pay your loan back.
- Pay less interest: You’ll usually pay less interest overall if you’re on a repayment mortgage, as you’ll be reducing your debt each month.
- Higher monthly repayments: Your monthly repayments will jump up if you switch to a repayment mortgage, as you’ll start paying back the loan itself as well as the interest.
- Early repayment charge: Not all lenders will let you simply switch your payment type. Instead, you may have to take out a new mortgage altogether, which could mean you’re faced with an early repayment charge (a fee that could add up to thousands of pounds).
- Interest rates could change: If you have to take out a new mortgage, your interest rates could change. This isn’t a problem if they go down, but they could also go up.
- Less flexibility: With an interest-only mortgage, you’ll save on monthly repayments. This means you’ll have more flexibility to do what you want with your money in the short-term, which could include investing it to make more money.
So, can I change my interest-only mortgage to repayment?
Yep! Changing from an interest-only mortgage to repayment is normally fairly straightforward (and a lot easier than changing your mortgage to interest-only!).
Put yourself in your lender’s shoes – while you’re on an interest-only mortgage, they’ll have to wait for potentially decades to get a single penny of the money they lent you back (assuming the interest doesn’t count). But if you switch to a repayment mortgage, they’ll get some money back in their pockets every month.
This makes it a lot less risky for them. So, they’ll probably be pretty happy that you want to make the switch. That said, there are a couple of things that you’ll need to bear in mind:
‘Affordability’ is all about how easily you can afford pay back your lender. Basically, switching to a repayment mortgage will mean you have to pay a lot more each month. And the last thing your lender wants is for you to struggle to pay them back. After all, you wouldn’t want to lend someone money if you didn’t think they’d be able to pay it back on time (unless you’re the loveliest person around!).
Before making a decision, your lender will do some checks to see whether they think you can afford it. If they’re not convinced then they won’t let you switch. It’s as simple as that!
Not sure you’ll be able to handle the repayments? Don’t worry. There’s also something called a part-and-part mortgage.
A part-and-part mortgage is where you pay back some of your loan on an interest-only basis and some on a repayment basis. Your monthly repayments will be lower than they would be on a full repayment mortgage. But you’ll also have less to pay as a lump sum than you would on an interest-only mortgage. So, it just takes the pressure off a little. We guess you could call it the best of both worlds!
2. Your current deal
Some mortgage lenders will let you stay on your current mortgage and just switch the way you pay. Happy days!
But others will want you to take out a new mortgage altogether. Let’s face it, this is essentially just remortgaging! Although this isn’t a problem in itself, it could mean leaving your current mortgage early, which could land you with an early repayment charge. This could come to thousands of pounds (don’t shoot the messenger!).
Similarly, switching to a whole new mortgage deal normally means you’ll end up on a different interest rate. Don’t get us wrong, this isn’t always a bad thing – you might actually find yourself on a lower interest rate than what you were on before! But there’s always a chance it’s the other way around. Just saying!
If your lender’s making you switch to a new mortgage, you’ll want to weigh up all these factors before coming to a decision. It’ll probably also be worth getting a mortgage broker involved so that you can compare all the deals available to you – not just the ones your current lender can offer you. At the end of the day, we all love a good deal. And why stick with the same lender if you can get a better deal elsewhere?!
How to switch from an interest-only mortgage to repayment
Switching to a repayment mortgage is (normally) as easy as pie. To get started, there are two main things you can do:
1. Contact your lender
Shoot them an email, pick up the phone or check out their website. Either way, most lenders will normally make it pretty easy for you to switch to a repayment mortgage.
Some will let you switch on an execution-only basis, which is where the lender just does what you ask them without giving you any advice. Others will get you to switch on an advised basis, which is what it’s called when your lender puts you in touch with one of their mortgage advisers to chat things through.
Just remember: they’ll need to check your affordability and get you to sign some documents before they make the switch official.
2. Contact a mortgage broker
A mortgage broker is someone who can help you to get the best deal on your mortgage. You don’t have to use one but... well... you’ll probably want to. Especially if your lender wants you to take out a new mortgage instead of just switching the payment type on your current one.
Basically, an independent broker can search the whole market for the best mortgage deals for you. This means they’ll be able to tell you whether you could save money by switching to a different lender altogether (a little clue for you: you probably could!). On the other hand, your lender’s advisers will only be able to tell you about their own mortgages.
In other words, you’re better off talking to someone who’s looking for the best deal for you, rather than the best deal for them! Our guide on whether you should remortgage with the same lender has the full lowdown.
Over to you
As you can see, an interest-only mortgage isn’t for everyone. But neither’s a repayment mortgage. And much as we’d love to sit here and tell you which is best for you, we don’t know what your circumstances are!
If you’re umming and ah-ing about making the switch, a mortgage broker can help. They’ll take the time to learn all about you and then, if you do decide to change to repayment, they can help you find the best deals. Meanwhile, you just sit back, relax and let them handle it all for you!