Interest-only mortgages

How interest-only works

You pay only the interest each month, so the monthly payment is meaningfully lower than on a repayment (capital and interest) mortgage. The mortgage balance does not reduce. At the end of the term you repay the capital from a defined repayment vehicle, sale of the property, an investment portfolio, a pension lump sum or an inheritance.

Worked example, monthly cost difference on a £400,000 loan

£400,000 mortgage at 4.5%. Repayment over 25 years: monthly payment around £2,224. Interest-only: monthly payment around £1,500. Cash flow difference £724 a month. Over a 5-year fix that is £43,440 of cash retained but not put against the capital balance. The repayment route ends year 5 with a balance of around £345,000. The interest-only route ends year 5 with the full £400,000 still outstanding. The cash flow saving is real; the trade-off is that the £55,000 of capital reduction has to come from somewhere else (investment, pension, sale).

Buy-to-let interest-only

Most buy-to-let mortgages are written as interest-only. The lender stresses the rent against an interest-only payment, which is what the ICR (Interest Cover Ratio) test is built around. Capital is usually repaid by selling or refinancing at the end of the term. Some buy-to-let landlords overpay over time to chip into the capital; most do not.

Residential interest-only

A narrower pool. Most lenders require a minimum income and a minimum level of equity, both set by the individual lender, and a credible documented repayment vehicle. The repayment vehicle test is real; sale of the main residence is sometimes accepted, sometimes not. Investment portfolios may be accepted as a repayment vehicle by some lenders, subject to their assessment criteria and valuation methodology.

Part-and-part

A part-repayment, part-interest-only structure is often the right answer. Take a residential mortgage with 60% on repayment and 40% on interest-only, manage the monthly payment, and chip into the capital each month. The lender pool for part-and-part is wider than for full interest-only.

What lenders accept as a credible repayment vehicle

Sale of the property: accepted by some lenders if there is significant equity and a clear plan to downsize. Investment portfolios: accepted with statements showing existing balance and projected growth, usually with a haircut. Pension lump sums: accepted at the projected drawdown date with a recent pension valuation. Sale of a business: rarely accepted on residential, sometimes accepted in HNW (High Net Worth) cases. Inheritance: rarely accepted at all. Endowment policies: still accepted on grandfathered cases. We package the right vehicle for the right lender.

Maturing interest-only loans

If you have an interest-only mortgage approaching the end of its term and you do not have the lump sum to repay, options exist: extend the term, switch some to repayment, refinance to a RIO (Retirement Interest Only) product if eligible, or sell. We have not seen a case yet where the answer was "do nothing"; the worst outcome comes from leaving it too late.

Common pitfalls we see

Treating interest-only as a permanent solution without an active plan to repay the capital. Picking sale of the main residence as the vehicle on a lender that does not accept it. Letting the term run to within 6 months of expiry before starting the refinance conversation. Underestimating how investment portfolio haircuts (often 50% to 75%) reduce the eligible vehicle value. We work all four with you.

Buy-to-let warning

Most buy-to-let mortgages are not regulated by the Financial Conduct Authority. Consumer protections that apply to your residential mortgage do not all apply to a buy-to-let.