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Repayment Mortgages Explained
In simple terms, a repayment mortgage is when you pay off both the value of your home and the interest accrued through monthly payments. By the end of the loan term, you will have paid off the entirety of your mortgage. It is the most traditional means of paying off your mortgage and remains the most popular mortgage type available today.
This mortgage type is notably different from interest-only mortgages, where all you have to pay every month is the interest accrued. By the end of an interest-only mortgage, you have to pay off the value of your home in full.
For this reason, interest-only mortgages are less prudent than repayment mortgages.
How do repayment mortgages work?
The amount you contribute to your mortgage each month will contribute to the paying off of your total mortgage loan amount.
At first, the amount you pay in interest will be higher than the amount you pay towards paying off your loan. After a while, the balance will shift, and the amount you pay towards your mortgage will be much higher than the amount you pay in interest. Your loan amount gradually reduces over time, meaning that the amount your interest is calculated against also reduces.
Once the balance has shifted, you may be able to apply for a deal with a lower interest rate. If you have cash available, you could even opt to pay more each month to clear your mortgage sooner.
Should I get a repayment mortgage?
A repayment loan is a good idea because it is the cheapest and most convenient way to pay off your mortgage. Unlike interest-only mortgages, you actually contribute towards paying off your mortgage loan each month.
Plus, as your interest rate lowers as your mortgage term goes on, repayment mortgages work out to be the cheapest mortgage option.
Repayment Mortgage Eligibility Criteria
The eligibility criteria for a repayment mortgage are the same as it is for any mortgage. Upon applying for a repayment mortgage, mortgage lenders will have to review your:
- Income
- Age
- Employment status
- Outstanding loans
- Credit history
- Debt-to-income (DTI) ratio
If any of the evidence you submit for the above categories is deemed insufficient, your application for a repayment mortgage may be rejected. For example, if you have a low credit score, your application may not be accepted.
Repayment mortgage income requirements
The income requirements of a repayment mortgage can be notably lower than that of an interest-only mortgage.
Mainstream mortgage lenders have been known to accept incomes as low as £20,000 for a repayment mortgage. Interest-only mortgages, on the other hand, normally expect your income to be around £75,000 and £100,000.
The reason for this is that repayment mortgages are generally viewed by mortgage lenders as being lower risk than interest-only mortgages. The borrower is paying off their mortgage on a steady monthly basis, which is better for the lender.
What Type of Property Is a Repayment Mortgage Best For?
A repayment mortgage is best for residential properties. You take out a mortgage on a residential property so that you can one day own the property outright. To achieve this, making monthly repayments to your loan amount until the end of the mortgage makes the most sense.
However, buy-to-let investors may not see the benefits of this type of mortgage. For them, it would make the most sense to use an interest-only mortgage so that they can make maximum profit from the investment without having to pay off the mortgage itself during the term length.
What Types of Repayment Mortgages Are Available?
Within this mortgage title, there are several types of repayment mortgages that you need to familiarise yourself with. These include:
Fixed-rate mortgages
In this type, your interest rate stays the same for a specified period. Such as 10, 15, or 20 years. Potential interest rate increases could occur after the stated period ends. However, fixed-rate repayment mortgages do provide a degree of stability throughout the initial years’ worth of monthly repayments.
Tracker mortgages
Tracker mortgages follow a specific base rate in addition to a set percentage. For example, your mortgage could follow the Bank of England’s base rate with a fixed percentage above it. The main advantage of a tracker mortgage is that you could potentially benefit from lower interest rates (therefore, lower monthly repayments) when the base rate lowers.
At the same time, this base rate can increase significantly, meaning you’d have to pay higher interest.
Discount mortgages
The lender has a set-variable rate (SVR) which discount mortgages track. A discount is added to this rate, normally around 1-2%. While receiving a discount is a positive, SVRs can fluctuate, making your mortgage repayments unpredictable.
SVR mortgages
SVR mortgages follow your lender’s SRV but don’t come with any discounts. The main benefit of an SVR mortgage is that there’s no penalty for overpaying or paying off your mortgage early.
Offset mortgages
With an offset mortgage, some of the interest you have to pay is offset by the money you have saved in a savings account. The only downside of this repayment mortgage type is that your linked savings account can’t gain any interest while it’s linked to an offset mortgage.
Guarantor mortgages
If you add a guarantor to your repayment mortgage, you can get a lower interest rate. A guarantor repayment mortgage is recommended for those who don’t have enough credit or don’t make enough income to secure a mortgage on their own.
What Is an Interest-Only Mortgage?
As we’ve already explained, an interest-only mortgage means you pay just the interest each month. You don’t pay off the mortgage during the term time. Rather, you pay this off at the end of your mortgage term.
How do interest-only mortgages work?
Given that this mortgage type only expects you to pay for interest, interest-only mortgages mean you make cheaper monthly payments. Normally, interest-only mortgage repayments are normally 100s of pounds lower than that of repayment loans.
But how does paying back your mortgage amount work?
If you take out a £300,000 interest-only mortgage, you’ll have to pay £300,000 back to your mortgage lender once the mortgage term time has ended.
For some, the capital needed to pay off the loan can be raised by selling the property for a profit.
Alternatively, some interest-only lenders invest and save up enough cash during the term time to pay off the loan.
Other methods include:
- Taking out another mortgage
- Taking a lump sum from a pension fund
- Selling off investments and assets, including stocks and shares
Can you switch between an interest-only mortgage and a repayment mortgage?
Yes, switching between an interest-only or repayment mortgage, or vice-versa, is possible. However, you’ll likely have to prove you have the funds or financial plan in place to successfully make the switch.
Should you get an interest-only mortgage or a repayment mortgage?
The decision here should come down to what you can afford and the type of property you’re buying. If you’re looking to own the house outright and are making enough to pay off the higher payments for a repayment loan, you should choose that.
Repayment Mortgages vs Interest-Only Mortgages: Pros and Cons
To further examine the benefits of repayment mortgages over interest-only mortgages, here’s a breakdown of the main pros and cons:
Repayment mortgages pros
- You will own the property at the end of the mortgage term.
- You don’t have to pay anything at the end of your mortgage term.
- Your interest rate gradually decreases over time.
- As your balance falls, you may qualify for better deals.
Repayment mortgages cons
- You pay more expensive monthly payments overall than interest-only.
- You pay more in interest initially.
- You have less disposable income during the first few years.
Interest-only mortgages pros
- You have smaller monthly payments to make with an interest-only mortgage.
- You can profit from investments on the side of your interest-only mortgage.
- You have much more disposable income.
Interest-only mortgages cons
- You do not outright own the property at the end of the mortgage term.
- You may have to sell the home to pay off the mortgage.
- You need to monitor both your mortgage as well as your investments.
- Your investment plans on the side may fail.
- If you fail to meet the terms of the mortgage, your house could be repossessed.
FAQs
What is the recommended mortgage repayment?
In terms of your monthly payments, you need to make sure your mortgage doesn’t exceed around 30% – 40% of your income. This percentage should be calculated post-tax. If you have other debt to pay, your mortgage monthly payments should be no more than 30% of your income. If you’ve got significant debt, you should aim for around 28%.
Can you pay off an interest-only mortgage or repayment mortgage early?
It is possible to pay off your mortgage early; however, you may be subject to an early repayment charge (ERC). This charge differs from lender to lender, while some lenders may not apply one at all. If you take out an SVR mortgage, you won’t have to pay an early repayment charge.
Additional sources:
https://www.money.co.uk/mortgages/should-you-get-an-interest-only-or-repayment-mortgage
https://www.cliftonpf.co.uk/blog/30082022143511–interest-only-vs-repayment-mortgage–which-is-best-/