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Repayment vs Interest-Only Mortgage: Which Is Right For You?

When buying a house using a mortgage, you’ll need to decide how you’ll repay it. For homebuyers, there are two main types of mortgages: repayment and interest-only. Before you can choose between them, you’ll need to understand what they mean and how they are different. Don’t panic; the experts here at Doctors Mortgages Online have put together this informative guide to repayment and interest-only mortgages to help make the mortgage process smoother for you.

What Is A Repayment Mortgage?

A capital repayment mortgage, also simply called a repayment mortgage, means that your monthly payments will go towards paying off the money you have borrowed to purchase your property and the interest charged on the loan. With this type of mortgage, you’ll make monthly repayments for the duration of the mortgage term, and at the end, you will own your home outright.

Advantages of Repayment Mortgages

Repayment mortgages are the most popular mortgage type out there. It’s what most people choose when buying a residential property to live in, as they’ll have the goal of owning their own home at the end of the mortgage term.

As well as being the popular choice for those who want the security of owning their home outright eventually, repayment mortgages have some flexibility throughout the term. At the start of your repayment term, a bigger chunk of your monthly repayment will go towards paying off the interest on the loan than the capital borrowed, but later on in the term, there will be less interest to pay as the sum you pay interest on will be getting smaller over time. This means that you will usually pay less interest overall, especially compared to an interest-only mortgage, as the amount you owe decreases.

As the amount you owe gets less, it might be possible for you to move to a better mortgage deal at the end of your fixed term, which could reduce your monthly repayments. You’ll also have the option to overpay on your mortgage – usually up to 10% of the total outstanding value for fixed-rate mortgages – which can help you get an even better mortgage deal at a lower loan-to-value (LTV) at the end of fixed terms.

What To Consider When Choosing A Repayment Mortgage

With a repayment mortgage, your monthly repayments will be more than an interest-only option, so you’ll need to ensure the monthly amounts fit your budget. While the amount you pay back is more, it’s important to note that it can take some time before the loan amount starts to decrease noticeably.

What Is An Interest-Only Mortgage?

As the name suggests, an interest-only mortgage means you only pay the interest off, not the capital borrowed over the term. Your monthly payments will be lower than a repayment mortgage because you only pay back the interest. However, it’s important to know that you will still owe the lender the money you borrowed at the end of the mortgage term, when you’ll need to repay the balance. These types of mortgages are commonly used in the buy-to-let market.

Advantages of Interest-Only Mortgages

Taking out an interest-only mortgage is another option you have when buying a property. Often, interest-only mortgages are taken out by people who want to invest their money elsewhere and sell the property for profit once the value has appreciated.

As mentioned, interest-only mortgage repayments are much lower than repayment mortgages, as you’re only paying back the interest on the loan, meaning you should have more disposable income at first. Interest-only mortgages are also a smart choice for investment-savvy buyers who want more control over their money and investments as you’ll be able to choose how you pay off the capital at the end of the term – usually either by selling the property for a profit, or with money you have saved and invested over the term with the view of paying off the loan amount.

What To Consider When Choosing An Interest-Only Mortgage

It should come as no surprise that the main thing you’ll need to consider when choosing an interest-only mortgage type is how you’ll repay the money at the end of the term. You’ll be required to pay this off in full so will need a credible repayment strategy to do so.

Mortgage lenders will not enter into an interest-only mortgage with the customer unless:

  • It has been given evidence that the customer will have a clear and credible repayment strategy in place.
  • It has been able to assess that the repayment strategy has the realistic potential to repay the capital borrowed and any interest that has been accrued during the interest-only mortgage term.

Lenders will not accept speculative repayment strategies in order to meet the above requirements.

In general, you’ll pay more interest on an interest-only mortgage as the amount you owe doesn’t get smaller as the mortgage term goes on. When you apply for an interest-only mortgage, you’ll usually need a much bigger deposit to decrease the LTV ratio.

Which Mortgage Type Is The Most Suitable?

The type of mortgage you go for will depend on your personal circumstances and goals. For most people, a repayment mortgage is a better and cheaper option for borrowing money than an interest-only one. If you want to discuss your mortgage options in greater depth, contact our team today; we’ll be more than happy to help you.

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