Repayment mortgages are the most popular type in the UK, however there are also interest-only mortgages. Before deciding which way to go, it's important to weigh up all the pros and cons of both the repayment type and interest-only mortgages.
Weighing up the pros and cons
Interest only mortgages
Just paying the interest
Interest only mortgage risks
Repayment mortgages
Buy-to-let investors
Interest only mortgages
With an interest-only mortgage, you repay the interest on your mortgage every month and pay off the capital debt - the value of the property - at the end of the mortgage. As you only pay off the interest, the repayments on an interest-only mortgage are cheaper than those on a repayment mortgage, where you pay off a combination of interest and capital debt each month.
But how do you pay back the capital debt at the end of the mortgage term? Unless you intend on selling your house to repay the capital debt - which is risky, as house prices are never guaranteed to rise, it's a good idea to put money aside each month, typically in some kind of investment vehicle, such as an individual savings account (ISA). This way, at the end of your mortgage term, if the value of your investment is greater than the outstanding debt, you could be left with some profit from your savings, as well as a lump sum to clear your debt.
Just paying the interest
In the boom years of the property market, increasing numbers of first-time buyers took out interest-only mortgages, and have just paid the interest, not paying any money into an investment. With high house prices, this was the only way some people have managed to afford to buy property. When taking out an interest-only mortgage and just paying the interest, borrowers relied on their property going up in value, being able to sell it a few years down the line for a profit, and then buying a property with a repayment mortgage.
Interest only mortgage risks
But this approach was fraught with risk. Firstly, house prices are not guaranteed to go up - in recent years they have fallen in most parts of the UK. Secondly, many people sort out their mortgage and then forget about it. If you never get around to converting your interest-only mortgage to a repayment-type, and you have no investment fund building up, there is a very real risk that you may get to the end of your 25 year mortgage term still owing all of the capital initially borrowed and with no way of repaying it.
To avoid this happening going forward, most mortgage lenders now make it very difficult for borrowers to take out interest-only mortgages. They may demand a very big deposit and/or ask for tangible proof that you have an investment plan in place to pay off the mortgage at the end of the term. And some have stopped accepting plans such as a future inheritance as backing for taking out an interest-only mortgage.
Repayment mortgages
With repayment type mortgages, the monthly repayment you make to the lender each month consists of the interest you owe plus a little bit of the capital you owe. If you keep up all the repayments on your repayment type mortgage, you are guaranteed to have paid off the mortgage at the end of the term. Repayment type mortgages are therefore the safest option, and are by far the most popular mortgage type in the UK.
Buy-to-let investors
Buy-to-let investors are the only borrowers who are advised to take out interest-only mortgages with no investment vehicle. That is because the rent covers your interest payments, and the long term plan is generally to sell the property in the future, and pay off the capital at that point.
