Interest only vs Repayment Mortgages
This week’s newsletter focuses on the two main types of mortgages offered in the UK- interest only and repayment mortgages.
Just as a reminder, ‘A mortgage is an agreement between you and a lender that gives the lender the right to take your property if you fail to repay the money you've borrowed plus interest. Mortgage loans are used to buy a home or to borrow money against the value of a home you already own.’
Repayment Mortgage
When a mortgage is obtained, a repayment mortgage states that the capital borrowed is paid back with interest (governed by the current interest rate). This payment is usually made monthly until the end of the mortgage term (20, 30, 40 years etc).
For the first few years, the proportion that goes towards the interest will be much greater than the amount that goes towards clearing your debt.
This changes over time, because the interest owed decreases in line with the size of the loan.
Having a fully paid mortgage means that the home is fully owned and is a sellable asset.
Advantages –
Less interest might be paid overall, as the amount owed decreases.
Interest rates paid might reduce towards the end of the term.
The home is owned at the end of the mortgage term (if all repayments are made).
Disadvantages-
Monthly payments will be higher than if one was to choose an interest-only mortgage. Online mortgage calculators can be used to work out how much your monthly payments are likely to be.
Interest only mortgage
An interest only mortgage means that the monthly payments on the mortgage are ‘interest only’, but at the end of the mortgage term, the whole balance of the mortgage is repayable.
This payment is usually made by –
1. Using a repayment vehicle (an investment you have running alongside your mortgage), including any type of savings plan (for example, an ISA, investment fund or pension).
The money saved by paying interest only can be used towards other investments which would’ve matured by the end of the mortgage term and could yield more value than the mortgage.
2. Using a lump sum that you receive before the mortgage ends- financial circumstances change, which may work in your favour.
Advantages –
Lower monthly payments, you are only paying back the interest on the capital.
Greater control over your investments- one can decide how you save to repay the capital of your mortgage.
Disadvantages-
The capital owed isn’t shrinking, so one might have to continue paying interest on the full amount.
At the end of the mortgage term, the initial amount borrowed is owed to the lender.
Higher amount of risk if your repayment vehicle performs badly.
Which is better?
This really depends on the person and their specific case, alongside other factors such as – residential vs rental, property location etc. One can switch from an interest only to a repayment mortgage, but this depends on the lender and is not guaranteed.
My Favourite Things this week
Podcast Episode: Inside Property investing – Episode 327: One House, Four Strategies- Which one is best?
A great podcast that thoroughly outlines various concepts relating to property in the UK. This episode broke down the thought process behind various property strategies that were considered by the host prior to closing a deal. I highly recommend.
Quote: ‘The beauty is in the process’ –
Remembering this helps me to always trust the process and not focus on the destination but spend time embracing the journey.
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