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The monthly cost of a £200,000 interest-only mortgage is the loan multiplied by the annual interest rate, divided by twelve, and nothing else. At X%, the monthly interest is £200,000 × X ÷ 100 ÷ 12. Every full percentage point of rate on £200,000 costs £2,000 a year, or £166.67 a month, so a rate one point higher adds £166.67 to the monthly payment and a rate one point lower takes it off. I do not quote rates in this article because they change too often for a written figure to be reliable, and the arithmetic is what matters.
What you are not paying is any of the £200,000 itself. At the end of the term the full loan is still owed and has to be repaid from somewhere else.
How does that differ from a repayment mortgage?
A repayment mortgage on the same £200,000 charges the same interest each month plus a slice of capital, so the payment is higher, the balance falls every month and the loan is gone at the end of the term. Interest-only has the lower payment and the £200,000 balance at the end. The full comparison is in my interest-only vs repayment guide.
Can anyone get a residential interest-only mortgage?
No. Lenders that offer interest-only mortgages on a home you live in usually want a large amount of equity, a minimum income and an accepted plan for repaying the capital, and they check all three. Buy to let is different, and interest-only is the norm there.
Monthly interest on £200,000 is the loan times the annual rate divided by twelve, so each 1% is £166.67 a month
The capital does not reduce on interest-only, so the full £200,000 is still owed at the end of the term
Residential interest-only usually needs substantial equity, a minimum income and an evidenced repayment vehicle
What does the arithmetic look like in pounds?
Take the loan and the rate and do it in three steps. £200,000 times the rate as a decimal gives the annual interest. Divide by twelve for the month. Then check the lender’s illustration matches, because most lenders calculate interest daily and the figure will differ by pennies.
If the rate is X%, annual interest is £200,000 × X ÷ 100 and the monthly figure is that divided by 12. Each full percentage point is £2,000 a year and £166.67 a month, and that scales in a straight line because there is no capital element to complicate it. Half a point is £83.33 a month. A quarter point is £41.67.
Compare that with repayment. On a 25-year repayment mortgage of £200,000, the capital element averages £666.67 a month across the term (£200,000 divided by 300 months), though the split is weighted towards interest early on and towards capital later. Interest-only removes that element entirely, which is why the payment is lower and why the balance never moves.
Over the term the cost difference is the interest on capital you did not repay. On repayment the balance is falling, so the interest charged each month falls with it. On interest-only the interest is charged on the full £200,000 every month for the whole term, so the total interest paid is higher, sometimes by a large margin, in exchange for the lower monthly payment.
Fees work the same on both. A product fee added to the loan on an interest-only mortgage is charged interest for the whole term and is still owed at the end. A £999 fee added to £200,000 makes the balance £200,999, and that is the figure your repayment plan has to cover.
Overpayments are allowed on most interest-only products within the lender’s annual limit, commonly 10% of the balance, and each overpayment reduces the balance and therefore the next month’s interest. That is one way of using the lower payment to build the repayment plan rather than spend the difference.
Who qualifies for residential interest-only?
Three tests, and lenders vary on each.
Equity. Most lenders cap the loan to value on residential interest-only below what they offer on repayment, often somewhere between 60% and 75%, so a £200,000 interest-only loan on a home you live in usually needs the property to be worth around £267,000 to £334,000 or more. Some allow part interest-only and part repayment above that.
Income. Many lenders set a minimum income for interest-only, set higher than for a repayment mortgage and varying widely between lenders, on the basis that a higher earner is more likely to repay the capital.
Repayment vehicle. The lender has to be satisfied the £200,000 will be repaid, will ask for evidence at application and may check again during the term. The accepted vehicles are: sale of the mortgaged property, usually with a minimum equity requirement at the outset so that downsizing is realistic; stocks and shares ISAs, with statements; a pension, using the tax-free lump sum, with projections; an endowment policy, with the latest projection letter; sale of another property you own; or a lump sum from a business or an inheritance, which fewer lenders accept. Cash savings are not usually accepted as a vehicle on their own.
Buy to let is different. Interest-only is the normal structure on a buy to let mortgage because the lender’s test is whether the rent covers the interest rather than whether you can repay the capital from income, and the usual repayment plan is sale of the property. In my experience buy to let clients typically put down 25%, and across the panel most lenders stop at 75% LTV, a few go to 80% and one goes to 85%.
What I see in practice
Sale of the property is by far the most common repayment vehicle I see accepted, both on buy to let and, with enough equity, on residential interest-only. ISAs and pensions come up, but the sale of the property is the answer in most of my cases.
Speak to an expert
If you are weighing interest-only against repayment on a home you live in, send me the property value, your income and how you would repay the capital and I will show you which lenders would consider it.
What is the risk at the end of the term?
The £200,000 is due in full on the last day. If the repayment vehicle has not performed, the property has not risen in value enough to downsize, or the plan was never really there, the options narrow to selling the property, remortgaging onto repayment at an older age with fewer years to spread it over, or a retirement interest-only mortgage, where the loan runs until the property is sold on death or a move into long-term care and only the interest is paid meanwhile. That route needs the interest to be affordable from pension income and is on my retirement interest-only page.
Lenders write to interest-only borrowers during the term to ask about the repayment plan, and it is worth answering honestly rather than filing the letter, because the options are wider with ten years left than with two.
Before choosing interest-only on a residential mortgage, check whether the lower payment is buying you something you will use. If the difference is going into an ISA or into overpayments, the structure is doing its job. If it is being spent, you have taken on a £200,000 liability with no plan to clear it. Whether interest-only, part and part, or full repayment fits depends on your income, your equity and what the money is for.
Your home may be repossessed if you do not keep up repayments on your mortgage.
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