Interest-Only vs Capital and Interest: The Key Difference
On a £300,000 mortgage at 4.5% over 25 years: a capital and interest mortgage would have a monthly payment of approximately £1,667, with the full £300,000 repaid by the end of the term. An interest-only mortgage would have a monthly payment of approximately £1,125 - a saving of £542 per month - but the full £300,000 capital would still be outstanding at the end of the 25-year term.
| Repayment Type | Monthly Payment | Capital Outstanding at Term End |
|---|---|---|
| Capital and Interest | Approximately £1,667 | £0 (fully repaid) |
| Interest-Only | Approximately £1,125 | £300,000 |
Repayment Vehicles: How the Capital Is Repaid
Lenders granting residential interest-only mortgages require a credible capital repayment plan - a specific, evidenced strategy for repaying the loan at the end of the term. Accepted repayment vehicles vary by lender but typically include:
Property Sale
The most commonly used repayment vehicle for residential interest-only mortgages. The borrower plans to sell the property at the end of the term and repay the mortgage from the proceeds. Lenders require evidence that this is a realistic plan given the property value and expected equity growth.
Investment Portfolio or Endowment
A stocks and shares ISA, investment portfolio, or maturing endowment policy can serve as a repayment vehicle. The current value and projected growth to term must be evidenced.
Pension Lump Sum
Some lenders will accept a pension lump sum as a repayment vehicle, subject to the projected lump sum being sufficient to repay the mortgage at term. Particularly relevant for borrowers approaching retirement who want to use a combination of their pension and the mortgage.
Sale of Other Property
Where the borrower owns other property, the planned sale of that property can serve as a repayment vehicle for some specialist lenders.
Interest-Only Mortgages for Landlords
Interest-only is the standard repayment method for buy-to-let mortgages. Landlords use interest-only to maximise rental yield - the lower monthly payment against a given loan amount means that the rental income generates a positive cashflow more readily. Most buy-to-let lenders offer interest-only without requiring a specific capital repayment vehicle, on the basis that the property can always be sold to repay the mortgage.
LTV Limits for Residential Interest-Only Mortgages
Residential interest-only mortgages are typically available up to 75% LTV from specialist lenders, with some private bank products going higher for the right profile. Below 60% LTV, the range of lenders offering interest-only residential products is widest. Above 75%, residential interest-only is very limited - capital and interest is the expected structure at high LTVs.