What is an interest only mortgage?
An interest only mortgage is a loan where your monthly payments cover only the interest on what you have borrowed. You don’t pay off any of the original loan during the mortgage term. At the end of the term, the full amount you borrowed must be repaid in one go.
This is different from a capital repayment mortgage, where each monthly payment reduces the loan as well as covering the interest. With an interest only mortgage, the balance stays the same throughout the term unless you make additional payments.
Because you’re only paying interest, your monthly payments are lower than they would be on a repayment mortgage of the same size. But you need a clear plan for how you’ll repay the full loan balance at the end.
| Interest only | Repayment | |
|---|---|---|
| Monthly payment covers | Interest only | Interest and capital |
| Balance at end of term | Full loan amount still owed | Zero |
| Monthly cost | Lower | Higher |
| Repayment plan needed? | Yes | No |
How do they work?
When you take out an interest only mortgage, your lender will want to understand how you plan to repay the loan at the end of the term. This is called a repayment strategy or repayment vehicle. Most lenders require you to have a credible plan in place before they will approve the mortgage.
The term of an interest only mortgage is usually between five and 25 years. During that time, your monthly payments stay lower because you’re only covering the interest. But, you will need to have a plan for making the full repayment.
For a deeper look at the mechanics, read our guide on how do interest only mortgages work.
Understanding repayment strategies
A repayment strategy is the plan you put in place to pay off the loan at the end of the term. Common strategies include:
- Investments or ISAs. You save or invest throughout the mortgage term with the aim of building a pot large enough to repay the loan at the end.
- Pension lump sum. You plan to use the tax-free cash from your pension at retirement to pay off the mortgage.
- Sale of the property. You intend to sell the home at the end of the term and use the proceeds to clear the debt. This is sometimes called downsizing.
- Sale of another asset. You plan to sell a second property, shares, or another investment to raise the funds.
Lenders will ask for evidence of your strategy. They may ask for statements, projections, or other proof that your plan is realistic.
Can I use multiple payment methods?
Yes. Many borrowers combine more than one method. For example, you might plan to use a combination of savings, a pension lump sum, and equity from the property. As long as the total is likely to cover the loan, most lenders will consider this.
Some lenders set minimum amounts for each repayment vehicle. For example, they may require your investment pot to cover at least a certain percentage of the loan. A broker can help you match your plan to the right lender.
Downsizing as an exit plan
Some borrowers plan to sell their home at the end of the term and move to a smaller, cheaper property. The difference between the sale price and the mortgage balance is then available to fund the move.
This can work well if you own a larger home and expect its value to grow over time. But it depends on the property market at the point you sell, and you need to be comfortable with the idea of moving when the term ends.
Not all lenders accept downsizing as a standalone repayment strategy for residential mortgages. It’s more widely accepted for older borrowers where it forms a clear and realistic plan. For buy to let mortgages, selling the property is a common and accepted exit route.
Can I extend my interest only mortgage term?
Yes, in some cases. If you’re coming to the end of your term and aren’t ready to repay the full loan, you may be able to ask your lender for an extension. Whether this is possible depends on your age, your income, and the lender’s policy.
Some lenders set a maximum age at the end of the mortgage term, often 70 or 75. If extending would take you beyond that age, they may not agree. Others are more flexible, particularly specialist lenders who deal with more complex situations of up to 80 years old.
If your current lender will not extend your term, you may be able to remortgage to a new lender who will. A broker can check which lenders are likely to consider you based on your age and situation.
To understand your full range of options when the term is coming to an end, read our guide on what happens when an interest only mortgage ends.
What if I can’t pay off my interest only mortgage?
This is one of the most common worries for interest only borrowers. If you reach the end of your term and cannot repay the full balance, you have a few options:
- Ask your lender for more time. Some lenders will give you a short extension while you arrange your finances.
- Remortgage to a new deal. You may be able to switch to a new interest only or repayment mortgage with a different lender.
- Switch to a repayment mortgage. If you can afford higher monthly payments, switching to a repayment mortgage gives you more time to clear the debt.
- Sell the property. If there’s enough equity in the home, selling and downsizing may clear the mortgage and leave you with funds to spare.
The worst thing to do is nothing. If you think you may struggle to repay at the end of your term, speak to your lender or a broker as early as possible. The sooner you act, the more options you’ll have.
Switching to a repayment mortgage
If you’re on an interest only mortgage and want to start paying off the loan as well as the interest, you can switch to a repayment mortgage. You can do this by remortgaging or, in some cases, by asking your current lender to change your mortgage type.
Switching will increase your monthly payments because you’re now paying off the capital as well as the interest. How much more you pay depends on how much you owe and how long is left on the term.
Some people switch part of their mortgage to repayment while keeping part on interest only. This is called a part and part mortgage. It gives you the lower payments of interest only on one portion, while gradually reducing the balance on the other.
To understand more about how the mortgage market has changed and what options are available today, read our guide on the current mortgage market.
Are buy to let mortgages interest only?
Most buy to let mortgages are taken out on an interest only basis. This is common and widely accepted by lenders. In fact, most buy to let borrowers choose interest only because the lower monthly payments improve the rental yield on the property.
With a buy to let interest only mortgage, the repayment strategy is usually the sale of the property at the end of the term. Because the property is an investment rather than a home, selling it is seen as a clear and practical exit route.
The rules for buy to let interest only mortgages are different from those for residential ones. Lenders assess them based on rental income and the interest coverage ratio rather than personal income alone. This makes them more accessible for landlords, even those with complex income arrangements.
The key difference is that on a buy to let interest only mortgage, the rent covers the interest payments. At the end of the term, you sell the property, pay off the loan, and keep any profit from the growth in value.
Ready to explore your options?
Interest only mortgages are available for both residential and buy to let purposes. But not all lenders offer them, and those that do have different criteria. Working with a specialist broker is the best way to find a lender who fits your situation.
This information is for general guidance only. Your own circumstances will affect what is available to you. Always speak to a qualified mortgage adviser before making a decision. Pepper Money works with several specialist brokers who understand this type of mortgage. Find a broker to talk through your options today.